Buy And Hold Is Dead, Long Live Buy What You Need

Buy and hold is a terrible strategy, if you aren’t paying attention to a company’s valuation or business strategy. Warren Buffett once said that his preferred holding period for a stock is forever. But I think he left out the part that you have to buy a company at the right price, the company has to have a sustainable business plan and you have to know when to sell. Easier said than done of course, but if anybody can help us figure out a “forever” stock, it’s Warren Buffett.

The first step to finding a forever stock is to focus on companies that sell products that we need to use everyday. These are the staples: food, beverage, heat, healthcare, financial services,electricity, shelter and entertainment. Look at Buffett’s forever stock holdings, American Express (AXP), Johnson & Johnson (JNJ), Kraft Foods (KFT), Procter and Gamble (PG), Coca-Cola (KO), Wal-Mart (WMT) you get the idea.

These are companies that provide products and services that we cannot live without. You’ll notice that there are no fad, fashion, or fantasy companies in Buffett’s portfolio. But Barry, aren’t Lululemon (LULU) and Facebook (FB) two companies that we use and need everyday? My wife sure spends enough time on Facebook and money at Lululemon, but I can’t tell you if she will be using Facebook or wearing yoga pants  five years from now. I can tell you that in five years, she will still be eating, she will be using her cellphone and buying pharmaceuticals at the drug store. Don’t bet on the horse, buy the racetrack.

The next step is to pay a fair price. We like to buy companies that pay dividends and have a history of raising dividends over time, companies with low debt levels, and companies that are trading at a P/E ratio at or less than the overall market. For example, if Coca-Cola was trading at 13 times earnings and the overall market was trading at 16 times earnings, that would be your clue to research its stock. Also it would be helpful if you were buying Coca-Cola at 13 times earnings when it has normally traded at 15 times earnings in the past. Unfortunately, Coca-Cola is currently trading at 19 times this year’s earnings, so I would avoid its stock for now.

Warren always says to wait for the fat pitch. The fat pitch happens when a stock drops for no reason or when a stock drops when it suffers a large but solvable problem. Wal-Mart dropping from $62 to $57 earlier this year on the news of a bribery scandal provided investors with a fat pitch.

Fat pitches also give you the opportunity to sell. Our clients benefited from Bill Ackman’s shakeup at Canadian Pacific Rail (CP). His involvement, moved the stock 25% higher giving CP Rail the highest valuation of all North American railroad companies. We couldn’t justify owning CP Rail, the least efficient railroad in North America, valued at 17 times earnings when its competitors trade at 12 or 13 times earnings. We sold all of our CP Rail to buy a competitor CSX Corp. (CSX) which offered a much cheaper valuation. By the way, Warren Buffet also invested in railroads with his purchase of Burlington Northern a few years ago.

Buy, hold and forget is dead. You must continue to put your investments to the test everyday and wait for your fat pitch.

Disclosure: Clients of Baskin Financial own shares in CSX and Kraft Foods and are waiting for the fat pitch on other stocks mentioned above.