How To Buy and Hold The Right Stocks

I am a big proponent of passive, buy and hold investing. One of the best quotes that sums up my approach to passive investing is from Warren Buffett, “Wall Street makes money on activity; you make your money off of inactivity.” It makes sense – Wall Street wouldn’t want people to stop trading, they would lose out on their fees and commissions. The investor that makes 20 orders a year is essentially worthless to a broker, as opposed to the trader who makes over 1000 orders a year. No wonder these online brokers always advertise ‘open your ‘trading’ account’, it’s never ‘open your long term passive investing account.’ They make loads of money off of retail investor in this way.

Passive, long term investing is the most rational approach to buying stocks for the retail investor because you save so much on fees. You also benefit mentally from a low maintenance portfolio management style that doesn’t require a lot of time inputting orders every day. As a long term investor, most of your time should be spent hunting around index listings for more phenomenal companies and doing research on Sedar.com.

The best buy and hold stocks have 3 fundamental characteristics that make them ideal for the long term investor.

1. Consistency of Earnings- When purchasing stocks to buy and hold for long periods of time, consistency of profits is an important thing to consider. If the business is making money one quarter and losing money the next, there should be no attempt to buy and hold. Consistency of earnings is a sign of stability and quality in the business. Usually these companies pay and grow their dividend over time. A good way to measure consistency of earnings is look at the income statement during the last few recessions. Did net income tumble dramatically from pre-recession levels? If net income was the same or kept growing during the recession, you may have found a good buy and hold stock candidate.

2. Room for Growth- Companies must have a clear plan for growth and operate in a big enough market to execute that growth over the long term. Pay close attention to market capitalization; a fantastic 300 million dollar corporation is probably more likely to outperform over the long term then a fantastic 50 billion dollar corporation. That’s not to say that a large company can’t be a terrific investment - just look at Warren Buffett’s Coca Cola investment. He bought in the late 80s when the whole company was worth about 10 billion, now the company is worth over 170 billion. Paying close attention to market capitalization helps you to know what to expect from a stock. For example, I don’t buy Colgate Palmolive expecting it to be a 5-bagger over the next 10 years. Because it is so big and sells into mature markets, you expect Colgate to give you slow and steady performance in good and bad markets, not explosive growth.

3. Special Intrinsic Characteristics- Intrinsic value is a well-known idea among value investors but it’s hard to identify and define. There is not one simple formula that defines intrinsic value; it is instead a combination of several special characteristics that ultimately produces intrinsic value within a business. These characteristics include a monopoly, a niche market, a unique business model, pricing power, brand power, reoccurring revenues, special management. Many times a company will have 2 or 3 of these characteristics making them more special than your average stock and usually worth a buy. These characteristics are all part of the ‘financial moat’ that all fantastic businesses have. Searching for intrinsic value in names that are relatively underfollowed can be very rewarding for the long term investor. Getting in before the big institutional money is why I am a fan of underappreciated and under followed small cap stocks.

If you can find special stocks with an intrinsic value, that have steady earnings and room for growth, then these are the best stocks to buy and hold for an indefinite period. This is summed up by Buffett in another of his quotes, “Time is the friend of the wonderful business, but time is the enemy of a terrible business.” When you buy wonderful businesses with a financial moat and room for growth, time is on your side.