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Buy-and-Hold is not Buy-and-Forget

The Peridot Capitalist wrote an interesting article defending Buy-and-Hold investing.  He argues that Buy-and-Hold doesn’t work if one ignores valuation.  I agree with him and would extend his argument to include that we can’t ignore whether a company’s franchise is getting strong and weaker while executing a buy-and-hold strategy.  Buy-and-hold, as practiced by Buffett and Munger, involves investing in companies with strong franchises. As time goes by, the franchises either get stronger as profits are reinvested in the business to create a stronger brand or expand distribution or introduce new products, or sometimes, franchises get weaker because of shifts in consumer tastes, increased competition or regulatory changes.  Monitoring changes in a company’s franchise strength is an important part of a buy-and-hold strategy.

Using Peridot’s Coke example, not only was valuation stretched in the late 1990s, but Coke’s franchise has weakened. Coke’s major market of carbonated soda drinks (CSDs) has stagnated. Consumers are shifting to healthier non-carbonated drinks such as water, iced tea and sports drinks. Coke missed a major opportunity to buy Gatorade’s parent, Quaker Oats, due to a board revolt against the CEO. Even though the price for Quaker was high at the time, the continued growth of Gatorade may have justified the acquisition. As a franchise like Coke’s gets weaker, investors are less willing to pay high valuations for the stock.

The advantages of Buy-and-Hold are the power of compounding and tax-deferral.  Potential Buy-and-Hold investments are companies that can compound their earnings growth at high rates of return for many years.  These companies are often in stable businesses or industries.  They may have pricing power over their customers or may have recurring revenues under long-term contracts.  These companies reinvest their excess profits back into their franchise to make it even stronger.  By holding the same stocks for years, investors are getting a interest free loan from the government by not having to pay taxes on gains until the investment is sold.

“Buy-and-hold” is not a “Buy-and-Forget” strategy. As Peridot suggests, the valuation of a stock is extremely important when buying a position. As time passes, investors also need to continually monitor the strength of the company’s franchise. As a company’s franchise weakens or threats to the business franchise emerge, investors should exit these long-term holdings.

At Gator Capital, we follow a buy-and-hold strategy but are rigorous about valuation and franchise strength. We do heavy valuation work prior to entering a position. We also monitor valuation through the life of the investment. We also assess the business franchise of the company and continually monitor the company for any changes in a franchise’s strength.

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