Week 212 - How Great is “Buy-and-Hold” Investing? Here’s a 30-yr Study.

Situation: One of Warren Buffett’s goals is to identify good companies, buy the stock, and hold it forever. Very few market commentators or analysts would agree with him on that point, and Warren Buffett himself is quick to close out a position if he detects an unanticipated change in its prospects. For his already wealthy friends and family, he suggests they put 90% of their new investment dollars in a Vanguard S&P 500 Index fund like VFINX. Here at ITR, we suggest that you combine two low-cost routes:
   1) add regularly to VFINX or its bond-hedged version, the Vanguard Balanced Index Fund (VBINX);
   2) add regularly to dividend reinvestment plans (DRIPs), making direct stock purchases online at computershare for example.
The idea is to favor stocks that have grown dividends at more than double the rate of inflation for at least past the 10 yrs (i.e., Dividend Achievers, see Week 205). If you’re 50 and expect to live to 80, that means you’ll have a 30-yr holding period for stocks that hopefully won’t have an unanticipated change in their prospects. 

Mission: See how well today’s Dividend Achievers did over the past 30 yrs compared to VFINX.

Execution: In addition to picking from the larger companies in the Dividend Achiever list, i.e., those that also appear on the 2015 Barron’s 500 List, we’ll draw data from our favorite databases: the BMW Method’s 30-yr statistical record for price appreciation, and the Buyupside total return stock calculator. 

We’re looking for stocks with price appreciation that beat the S&P 500 Index (^GSPC) over the past 30 yrs, and also had total returns that beat VFINX. To address risk, we’re looking for stocks that 1) have a statistical risk of future bear market losses that is less than that predicted for ^GSPC, and 2) lost less than VFINX in the Lehman Panic. We’ve excluded some stocks that pass those tests for the following reasons: 1) If their price variance hasn’t tracked ^GSPC’s, and 2) if their dividend hasn’t grown faster than the 5.2% rate at which the dividend for VFINX grew. Finally, companies with an S&P bond rating lower than BBB+ or an S&P stock rating lower than A-/M were excluded.

We’ve turned up 11 stocks (see Table). So, you can take a buy-and-hold approach to stock-picking without sacrificing returns and still benefit from dividend growth that beats VFINX. But risk remains a sticking point. While we’ve gone to great lengths to isolate a set of stocks with long-term risk that is less than that for ^GSPC and its total return version (VFINX), in the short-term we’re including stocks that have 5-yr Beta values greater than the S&P 500 Index (i.e., 1.00), and stocks that are overpriced relative to earnings, i.e., those with a P/E higher than VFINX (i.e., 20). Either will produce greater price appreciation in a bull market and greater price loss in a bear market. In other words, stocks with above-market 5-yr Betas and P/Es are destined to have above-market volatility over the near-term. If we were to eliminate such stocks there would be none left. If we did the same evaluation but limited the holding period to 25 yrs (see Week 199), only two stocks had a P/E that was equal to or less than the market’s and a 5-yr Beta that was less than or equal to 0.9. Those stocks are Baxter International (BAX) and Illinois Tool Works (ITW). By limiting the holding period to 16 yrs (as you’ll see in an upcoming blog), only 3 companies survive the screen: Wal-Mart Stores (WMT), Union Pacific (UNP), and DTE Energy (DTE).

Bottom Line: Buy-and-hold stock-picking isn’t a logical option compared to picking a low-cost S&P 500 index fund like VFINX. As we were taught in business school, the only lawful way to beat the S&P 500 Index is to take on more risk. But stock-picking can work in your favor over the long term, if you’re willing to dollar-cost average. In other words, you can use dollar-cost averaging to defeat near-term risk by riding out bear markets, if you continue to add fixed dollar amounts to your DRIPs while stocks are cheap. 

Risk Rating: 5

Full Disclosure: I dollar-average into ABT and also own shares of MCD, GIS, BDX, MMM, and UTX.

Note: For this week only, the metrics in the Table that are highlighted in red indicate underperformance relative to the Vanguard 500 Index Fund (VFINX), not the Vanguard Balanced Index Fund (VBINX) as in our previous blogs. That is because VBINX wasn’t launched until 1992. Metrics are current as of the Sunday of publication.

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