Is Buy and Hold Dead? Performance Update.
June 2, 2009 | Joe Ponzio | about: DBB / JNJ / MMM / NTRI / WFC / WMT
I can’t believe that it has been nearly two years since F Wall Street was originally launched on June 25, 2007. And what a two years it has been!
Since our launch, we saw the S&P 500 climb to an all-time high in October of 2007, only to watch it plummet nearly 58% to a level first seen in May of 1996. Some of the causes of the drop were highly predictable. Some of the events, such as the September 2008 disaster, were completely unpredictable. And through it all, we were largely, if not entirely, invested in individual stocks.
Let’s see how we did.
Portfolio Performance
If you recall, I started the F Wall Street portfolio with $100,000, and compare it to the Diamond Trust Series (DIA) – an ETF that tracks the Dow – and the Vanguard S&P 500 index fund (VFINX). I compare to these two funds because investors can’t invest directly in an index; so, these are two of the broad “index-type” investments.
In the roughly two years since F Wall Street was launched, $100,000 in the F Wall Street portfolio grew to $103,224 (+3.2%) while $100,000 invested in the DIA and VFINX fell to $68,246 (-31.8%) and $63,225 (-36.8%), respectively. On an annualized basis, we have outperformed the better of the two investments (the DIA) by 19.6% per year.
What’s In Our Portfolio?
The portfolio snapshot below is as of yesterday’s close. This morning, I sold DBB because it didn’t work out as planned. I will discuss it in a later post.
Thoughts on Our Portfolio and Performance
Had I been able to spend more time and energy on the blog, I am certain that our results would have been much better. As the markets plummeted, I found myself with less and less time to post, as is indicated by my lack of activity here over the past year. I first mentioned this problem in March of 2008 in this post:
When the markets were flying high, I had all the time in the world to write posts for an hour or two a day. Trying to maintain that pace in this market would be detrimental to our future returns.
It is important to remember that I am not a professional blogger, living off advertising revenue and blogging for dollars. Nor am I a professional author, living off book royalties. (Trust me – there’s no money in writing books unless you’re Steven King.)
Some opportunities that were missed in the F Wall Street portfolio:
- Graham Corporation, which was discussed ex post facto and never included in our results.
- The InBev acquisition of Anheuser-Busch workout which, at one point, offered a substantial premium.
- As I mentioned in this interview on First Business and back in November to my friend Barry Pasikov, Managing Partner at Hazelton Capital Partners, Sears Holding Company was an amazing opportunity in November, when it was trading at just $30 and less.
- And, of course, Wells Fargo which, in February, fell to just $7.80 a share. In response to Dan’s question whether or not WFC was a screaming buy, I responded: “Screaming,” but didn’t have the time to post more about it.
These investments would have had a significant impact on our results. The total impact of these investments, as of June 1, 2009, would have added another 33% or so to our returns, broken down as follows:
- about 2.5% from Graham, in which a 5% investment would have doubled,
- about 0.5% from the InBev workout, in which a 10% investment would have grown about 5%,
- 10% from Sears Holding Company, in which a 10% investment would have doubled, and
- 20% from Wells Fargo, in which an additional 10% investment would have tripled.
And that’s net of some of my more boneheaded moves, like overpaying for American Eagle or getting my butt kicked in the Landry’s workout-gone-bad.
The point here is not that I’m backward looking or playing with the numbers, but that the market presented investors with some amazing opportunities over the past year, if, of course, you were looking at the business and not the media or stock markets.
On a relative basis, I’m bubbling over with joy at how we continue to outperform the markets and at the amount of safety our portfolio enjoys. On an absolute basis, I am upset that I didn’t have more time to discuss some of these amazing opportunities in greater detail and include them in the F Wall Street portfolio.
Still, we own some wonderful businesses at great prices. While my primary responsibility is to manage money for our clients, I will continue to run the F Wall Street portfolio on this part-time basis because, as I discuss in the book, casual investors can invest conservatively, confidently, and at satisfactory rates of return without taking a lot of risks. This portfolio will continue to be run “casually,” unlike the portfolios we manage at Ponzio Capital.
Thoughts on Diversification and Buy-and-Hold
Clearly, and once again proven over time, broad diversification just doesn’t cut it. Having extremely small positions (1% of the portfolio, or broadly diversified mutual funds) doesn’t allow your best ideas to have a meaningful impact on your returns. And though the losses have a greater impact (and we’ve had a few), a 5% loss in the portfolio due to a 50% loss on a 10% position is not impossible to overcome, so long as you can remove emotion and media hype from the equation and focus on making smart business decisions.
The number of positions an investor should hold is inversely correlated to the predictability and discount one receives in any investment. You could put your entire net worth into a single U.S. Government bond, and never diversify outside of that one bond because you have absolute certainty and predictability. Conversely, if you’re going to invest in a highly speculative, debt-laden, poorly run company, you wouldn’t want to risk too much of your savings.
That, of course, is one of the problems with mutual funds, and particularly index funds. Both the DIA and VFINX held General Motors as it fell from $90 to bankrupt and worthless over the past ten years. From a value standpoint, it was as worthless at $90 as it is today; however, if you have to own a GM (like when you invest in index funds), you certainly want it to be a very small portion of your portfolio.
This, of course, leads us to the constantly-asked-and-wrongly-answered question: Is buy-and-hold investing dead? The short answer is an emphatic “no.”
Whether stocks are rising, falling, or hanging flat, Wall Street wants you to believe that “it’s a trader’s market.” When the markets are rising, it’s a trader’s market because easy profits are aplenty. When the markets are falling, it’s a trader’s market because you need to be nimble and liquid. When the markets are flat, it’s a trader’s market because “buy and hold ain’t working” and you have to do something to make money.
The truth is that it’s always a trader’s market on Wall Street because Wall Street gets paid when you’re buying and selling. The broker handling the F Wall Street portfolio couldn’t buy an iPhone with the money he would have made from us.
Buy-and-hold is a poor strategy if you’re buying anything at any price, and holding it no matter what. If, however, you are buying great businesses at great prices, the overwhelming majority of active traders won’t be able to match your results over the long-term.
I had written the following to clients a few weeks back about this exact topic. Though it’s not an exact comparison, I think you’ll get the gist of it:
Warren Buffett has built his fortune on buy-and-hold investing. His company, Berkshire Hathaway, is not only larger than every brokerage firm in the United States (many of which are much older than Berkshire Hathaway), but it is larger than Goldman Sachs, Morgan Stanley, State Street, Citigroup, Charles Schwab, and E*TRADE combined. (Based on market capitalization at the close of business on May 7, 2009.)
A Final Thought, On Volatility
It’s easy to look at our results and think that the ride was smooth. All you see in the above chart is three points in time, and a straight line joining each of them. The truth is that the results were volatile, and we suffered wide swings in the prices of each of our investments.
There is no way to control the daily swings of the markets or any individual position. Then again, there is no need to worry about it if:
- You hold great investments at great prices, and
- You have no intention of selling that day.
When the markets pounded Wells Fargo down to $7.80 per share, we were down 67% from our initial purchase at $23.41. We invested again at $16.63, but that only gave us an even larger loss on a dollar-basis, and we were still down 63% in a matter of days.
It’s easy to sweat over the market action if you need to sell, or if you don’t fully understand your reason for buying. Even my own brother, whom will remain nameless but trusts me implicitly (I have four, so don’t try to guess), commented on the unrealized loss and was tempted to swear off stocks completely until we had more clarity in the markets.
The truth is that stock prices, on a daily, monthly, and even quarterly basis, are quite silly. Buffett and Munger commented on this at the annual meeting, I discuss it in detail here on the site and in the book, but I’ll reiterate it: A major key to the success of one’s investment program is having the right emotional make-up to handle the market’s ridiculousness.
As I stated in this post, most people don’t have the emotional constitution for investing in stocks. With the markets down nearly 40% from their October 2007 highs, people that were plowing money into stocks two years ago are now sitting on cash and looking for bonds. It’s not just individual investors – many pensions, mutual funds, and other institutions operate with this backwards mentality that investing should be done when prices are high and may go higher, instead of when prices are low, even if they go lower.
Over the long-term, the markets work very well; but, your investment results will depend on how much time you can put into your investing and how well you suppress your emotions while focusing on making smart business decisions.
The results of the F Wall Street portfolio will not do as well as I’d like going forward (that is, very high, non-conventionalist returns) due to my lack of time for blogging; so, I’ll focus on trying to make smart business decisions when I can post here.
(Of course, we’ll keep on trucking at the firm!)
Dominic Z: Not at all. Two years ago, I was posting almost every day. That has certainly fallen off, and I don’t expect it to pick up soon. My point here was that I can’t run (and haven’t been running) the F Wall Street portfolio full-time. Sorry for the confusion!
anon: I’m not upset, but I am apologizing for the fact that the blog portfolio missed some great opportunities that I would have liked to have explained better, and in a more timely fashion. Our performance was great, and an investor that isn’t bound by the constraints of posting on a timely basis could have certainly taken advantage of the opportunities I mentioned and done significantly better than we did on this website.
( REPLY )
A definite shame that you will not be blogging as often since this is arguably the best website for investing that I have seen to date.
I follow a similar school of value investing and would classify myself as a non conventional stock investor and definitely follow the buy and hold approach with a few caveats as listed on my website,www.globalstockinvestingtoday.com.
Like yourself despite the jaw dropping falls on stockmarkets worldwide,I too am sitting on an inconsequential paper loss after 11 months from launch and will publish my first 12 months results on 1st July despite making mistakes on some stock picks.
The difference being that I am based in Hong Kong,have better insights on stocks listed on the Hang Seng and compensated for my current paper losses on the S&P and NASDAQ by my Chinese picks as well as my correct analysis of a major bank that is not listed in the US but is listed in Hong Kong and London,Standard Chartered.
At one point the Hang Seng was insanely undervalued at 11,000 (a fall of nearly 67% from its peak)and was a value investor’s dream.
( REPLY )
Great post as usual, Joe. Is it ever not a trader’s market on Wall Street?
I’ve got an idea for a new show on CNBC. Stay with me here.
“Slow Money with Joe Ponzio.”
It would air right after that one with the neon green lights and the four traders on speed. I’ve even got your intro already scripted for the first show:
“Everything those guys just said is useless. The market was (up/down) today because of random Brownian motion. But if you didn’t look hard at Wells Fargo when I said to in January, now’s your chance. And…that’s a wrap! Tune in again in six months. Now, here’s some other clown.”
It will kill. Performance-wise, anyway. Ratings? Well, the FWallStreet army could help with those.
Think about it. I think it’s a winner. In fact, I’m going to go Tweet the idea right now….
( REPLY )
Congratulations Joe, good job. I haven’t done my “monthly” calculations for about three months, but I think I’m finally in the black now. Just one stock held me down otherwise I would have done better, but c’est la vie, live and learn and all that. How do you sell a stock? I need to know, because sometime this year I will sell my one big loser for the tax break. Seriously, I have never sold a stock yet and I still like my holdings except for the one which I still like, but see other places that are better.
As for your future CNBC show, it should feature guests asking you questions, to which your response is a Kramer-like sound effect of a very loud raspberry accompanied by a short flash animation of the guest being ejected from his/her chair and off the show 99% of the time, with the remaining 1% getting an actual answer to a non-idiotic question. You could be the financial Colbert. Call it the Ponzio Report.
( REPLY )
Thanks all!
China is a great growth story and I’d likely invest in a few companies through ADRs, but the whole communism/capitalism blend and weird share structure worries me. About China, I always say that there are certaintly enough opportunities in the U.S. that I don’t worry about missing a Chinese boat. Or, to paraphrase Munger at this year’s annual meeting: “People will always do stupid things so there will always be opportunities for us!”
Cale & Rene: If I ever start a tv show, buy stock in coffee companies. Between me sipping coffee while pouring over annual reports, and the audience chugging coffee to try to stay awake while I bore them to death, SJM (Smuckers, owner of Folgers) will soar!
I’ve got sound effects for Wall Street, but I don’t know if they’d be allowed on air!
( REPLY )
Hi Joe
I don’t understand how you achieved a gain of 36.25% with Nutrisystem, because you purchased it at $13.79 which you wrote here: http://www.fwallstreet.co...
I would say it is 7.6% instead of 36.25%
( REPLY )
In Seth Klarman’s Preface to the SIxth Edition of “Security Analysis” he talks about cable news channels, alludes to Jim Cramer when he states “Only on financial cable TV would a commentator with a crazed persona become a celebrity…” and “..human nature virtually ensures that there will never be a Graham and Dodd channel.”
( REPLY )
Joe or anyone else,
I know very little about US taxes (as this question reveals), but is there a way or some sort of account or fund I can set up, so that I can reinvest dividends without getting taxed on them?
I am 22 years old. If I can put $5000 in a company that pays a 5% dividend, I receive 250 dollars per year, of which I would have to pay 30% to the gov’t, or $75 in taxes. If I plan to invest it for the next 43 years (until I’m 65), and I could potentially return 10-15% per year in my investment portfolio, it could be the difference between an additional 10,000-30,000 down the line.
As of now, I have a bias towards non-dividend paying stocks, but I do like the idea of physically getting money back from the companies I own, so I would like to invest more in dividend-paying companies. If anyone knows of any way to deal with this issue, please respond…
thanks!
( REPLY )
g: set up a Roth IRA if you have earned income but don’t make too much money (more than like $75 or $80K I think if you’re single). All the dividends and cap gains will grow in the account tax free and will be tax free upon withdraw. You could also set up a traditional IRA but you will pay taxes on the account upon withdrawal and your ordinary income tax rates (but you can deduct the annual investments into the traditional IRA if your employer doesn’t offer a 401(k) plan.)
( REPLY )
Hi Joe,
Read your book. Without a doubt, one of the best and useful books I ever read. Most of the other books beat around the bush and does not provide any specifics. Thank You!!
Will you be able to share the numbers/workout excel sheets you used while making the investment in NutriSystems? I think it will help to look at a real life example where you made an investment and compare with the calculations I/others have done.
Thanks,
George.
( REPLY )
May be “buy and hold” is not the right phrase for the style of investing that we espouse but more towards investing as if we are owners of businesses?Certainly that is what helped me begin my first year with a significant outperformance compared to the global stockmarkets as is now published on my website http://www.globalstockinvestingtoday.com.
With regards to China,I do not believe that in this century that funds will offer the best returns for the least risk if they do not invest globally since the US economy is unlikely to generate the levels of economic growth that led to such handsome stockmarket returns from 1960 to 1999.
Certainly,my portfolio performance would have been diminished without the returns generated from Asian equities.I am also amazed that the US investment community is so underexposed to Standard Chartered Bank simply because it is not listed in the US but is now Britain’s second largest bank by market value due to nearly all of its business being in Asia and the Middle East.It is my Wells Fargo.
( REPLY )
Looking at Joe’s NAV chart, an immediate thought was “that result is very do-able with $100k across say 8 small caps”… but it’s the blue chip holdings in the portfolio that mark this out as a great performance.
If all businesses (and portfolios) are simply RoIC machines that you try to shovel as much capital/ reinvestment into as possible whilst maintaining high RoIC, then Joe’s portfolio could take in $100 million, surely?
To put this into perspective, my own investments are in such small caps that £7m is about the ‘headroom’ limit before reaching an unwieldy >2% stake in each. Good RoIC but very limited reinvestment capacity.
Hats off, Joe.
( REPLY )
George: I’ll have to dig it up. Give me some time and I’ll post it for you.
Billy Basu: That’s why I’m pushing for a new term – Business Investing. Of course, there’s no formal investment terminology authority, but there’s still plenty of U.S. bailout money available. Perhaps a market language regulator?
Karl: The strategy works fine up to, in my opinion, $1 billion or so. Above $1 billion, Workouts become scares. Above $10 billion, you can basically forget about Workouts. If F Wall Street takes you from $x up to $1 billion, let me know and I’ll write F Wall Street 2: Joe Ponzio’s No-Nonsense Approach to Rewarding the Author That Helped You Become a Billionaire ☺.
( REPLY )
G: You may be all set with regards to your tax question, but if you work for a “larger” company, the 401(k) plan would be good if you get a match, but better would be the Roth 401(k) option if available. Outside of that, the regular Roth IRA, as BPal mentioned, would be your next best thing. My problem with using a regular IRA (or non-match 401(k)) is that you will turn capital gain income over time into ordinary income, most likely in a higher tax bracket down the road. And since you are on the site, you most likely will have a high level of income in your distribution years. 
It is nice to be able to defer and reinvest the dividends, but that is only part of the problem. Hopefully our gov’t will change the dividend reinvestment tax laws some day, but that is doubtful under our current administration. Also, consider liquidity as well. Yes you can get to those accounts, but you pay a hefty price for taking that money out. Yes there are exceptions, but they are finite. Point of post, tax on the dividend is not the only question you should be asking.
( REPLY )
Hi joe,
I just wanted to ask you if depending upon morningstar for numbers is a good idea.I don’t read sec filings and letter to shareholders.similarly, I know we can know if a company has a moat or not by looking at ROA ROE CROIC but I wanted to know what kind of moat it is.intangible asset, switching cost, network effect and low cost are moats but how can we identify it.
Suggestions plz….
( REPLY )
Avishek- if you don’t mind a few thoughts to your post from this anonymous guy…
Two parts to your post; 1. determining whether a company has a moat and 2. identifying the type of moat.
1. I’d be wary of relying on for example “Morningstar’s moat assessment”. Established moat companies have a premium stock market valuation due to such widely accepted dogma as “this company has a moat”. Investing in say 10 wide moat companies as defined by Morningstar might produce a small gain over the market.
But to significantly outperform the market, that leaves us with picking companies:
a. hit by short term bad news but with known moats still intact or
b. have unknown moats that we identify before the market does (e.g. small caps, short term high RoE but with high probability to continue this for a decade ).
2. To perform either a. or b. requires identifying the moat. You list the sources of the most enduring moats, but to identify those sources yourself requires a little studying. I’d recommend starting off with Pat Dorsey’s little yellow book and Bruce Greenwald’s Value investing book’s section on why Earnings Power can rise above Asset value to connect the moat with company valuation.
But what is the good of identifying the source of the moat if you don’t know it’s dynamics (declining/ increasing and duration)? Since buying a high valuation company with a known, but long-term declining, moat will simply strip money from your portfolio. To know the dynamics of a moat requires studying the moats themselves AND how they relate to your ‘circle of competence’ industries.
(The more you study moats, the more they become termed “competitive advantages” and the further you go into business strategy- strategy’s sole function is to create a moat).
To further study moats beyond Pat Dorsey’s book, I’d recommend reading some of the articles at CAPatcolumbia.com (esp. “All Strategy is Local” and the RoIC article). Next Michael Porter’s “Competitive Advantage” and Besanko’s “Economics of Strategy”.
Also Charlie Munger’s mental models (in his Almanac) that introduce you to moats relating to ecoysystems and small world networks and customer’s cognitive biases.
Finally (perhaps), your study of moats could enter the busines strategy discipline. To save sanity and keep strategy’s relevance to investment returns, I’d stick with resource-based strategy theory and stuff connecting strategy with shareholder returns (e.g. Alfred Rappaport’s writings). Mintzberg and Ohmae and other strategy writers are very whimsical from an investor’s perspective.
Moats can rapidly become worthless. Some intangible assets like patents in certain industries are easily overcome. Some switching costs like media companies supplying TV and telephone are useless if rivals start paying customers to switch. Network effects are very enduring but very rare. Lowest cost is great until the high fixed cost part of your business structure (creating the economies) leaves you rigidly stuck in serving that one type of customer/ creating that one type of product, and diseconomies take hold.
If the above sounds like too much work at just 3 months reading, well we’re only going to find $1 selling for 50cents (30% average annual returns) by thinking differently to others, not through following pre-fomulated Morningstar numbers. And Ben Graham said investing is most intelligent when most business like. So, studying competitive advantages (Buffett’s moats) will take you far away from the chattering and garbage of the investing world.
( REPLY )
Pretty darn impressive Joe. Great job. I have a question about your tone. Is the blog coming to an end?
( REPLY )