What You Need to Know About the Buy-and-Hold Strategy
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If you want to make money in the stock market with a time-tested method, you should consider buying and holding stocks. With the buy-and-hold approach, investors buy stocks and hold them for a year or more. The best stocks to invest in for buy-and-hold investing are large-cap industrials, those widely traded, highly liquid stocks of established, solid companies. These stocks often have a history of paying dividends, which is a way for the investor to earn some money while waiting for the stock price to go up.
Because the holding period in the buy-and-hold approach is usually a year or more, this long-term investing method lends itself to buying and holding value stocks. Value stocks are those which are considered underpriced and are expected to appreciate over a year or more until they reach what the market considers a fair or full price. If the investor has bought them at a low price, he should eventually make money.
Stocks that are growing more rapidly, with new products or in newer industries, are called growth stocks. Some of these stocks fit the buy-and-hold approach, too, especially if their price increases are gradual and investors are able to buy them at a low price and hold them. Sometimes value stocks, which may have been growing gradually, have an extra growth spurt that adds to their price appreciation, so this can pay off even more for the long-term buy-and-hold investor.
Fundamentals: The Key to Buy and Hold
When you consider buying a stock as a buy-and-hold investment, look at the fundamentals. Fundamentals measure the performance of the company underlying the stock. Remember, when you purchase a share of stock, you are purchasing a small amount of ownership in a company, a piece of its future earnings.
One of the most important considerations of a company is how much it is earning. Earnings are an important indication of how a company is performing. Are the earnings stable? Are they growing? The earnings history over several years can often be an indicator of how the company might do in the future.
If a company has been increasing its earnings by an average of 10% annually for the past five years, but then its growth slows to 5%, you should look into why this growth trend has fallen off. Perhaps it is because of overall business or industry conditions, or perhaps the company’s management is not performing as well. Conversely, if the earnings trend is increasing, assess why that is happening and if it’s likely to continue.
Price-to-Earings Ratio (P/E) is a measure of value expressed as a ratio that tells how much an investor is paying for a prospective dollar of the company’s earnings. The P/E is calculated by taking the current stock price and dividing it by the earnings per share. For example, if a stock is selling at $10 and earns $1 per share annually, the P/E is 10. If the stock is selling at $20 and earns $4 a share, the P/E is 5. A low P/E often represents a bargain price, as it’s obviously a better deal to pay only five times, rather than 10, per dollar of earnings. You should compare stocks only in similar industries to each other, for example utilities to utilities or technology stocks to technology stocks, when comparing the P/Es. There also may be times when a P/E is extremely low for a stock not because it’s a bargain, but because its business prospects are poor.
Many established companies pay a portion of their earnings out to investors in the form of a dividend. Ideally, this means that the company is doing well enough in business to have excess cash to pay a dividend. Many successful companies increase their dividend payments each year, and some have a long history of many years of increasing their dividends. These dividend-paying stocks are often ideal for buy-and-hold investors. The dividend which you are paid while you hold the stock adds to your total return when the stock price eventually goes up.
Cash flow is the amount of cash coming in and going out of a company as an annual measurement and includes revenue and expenses, along with financing and investing activities. Cash flow gives a picture of how much cash the business is generating and spending and has often been called the lifeblood of a business. It is an indicator of the financial health of the business.
A high amount of long-term debt, particularly when it’s not covered by cash on hand can be a concern, while a low amount of long-term debt is more desirable. This is an obvious measure of a company’s overall financial health.
The book value is the measure of what a company is worth if everything were liquidated, assets minus liabilities. If the company has a book value of, for example, $25 a share, but the stock is selling at only $15 a share, this represents a potential bargain, as an investor has a chance to buy the stock by paying less than the company is worth.
For Buy-and-Hold Success
The above indicators will supply you with plenty of reliable information on which to base your buy-and-hold decisions. You should also evaluate the company’s business prospects, whether it’s in a healthy industry and whether it’s developing new products, new markets or growing market share. Constantly monitor the fundamentals after you’ve bought the stock; don’t just buy the stock and forget it. Although many have said in our modern markets that the buy-and-hold method is dead, it is still a time-honored, successful strategy that has and can still lead to great wealth.
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