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But as everyone who has ever tried to dabble with these unproven-but-lots-of-possible-potential investments knows, attempting to spot the really promising companies and picking the winners is not an easy task. Darts and the Financial Times, and all that.
Thus my proposal for a spread of "boom or bust" type equity investments could, perhaps, lead to long-term portfolio success. Just one winner in the pack will do. For instance, an early purchase of Amazon.com (Nasdaq: AMZN) or Glaxo Wellcome (LSE: GLXO) would have offset many other misjudged investment decisions.
But as I mentioned in the last week's piece, the point to note with this type of investing is that there is far more hope than analysis in the "buy" decision. But of course, when there is little analysis, there is usually little understanding of the company that you have become a co-owner of. And when there is little understanding of the company, investors tend to use the share price as the sole guide of company performance.
Quickly banking your hopeful profits
So, here's a potential snag with the "hopeful" strategy. With the type of equity investments to be made, there's the opportunity to make significant gains in a short period of time. With only hope supporting the share prices, any positive noises from the company can significantly inflate investors' optimism for the future.
Take Cambridge Antibody Technologies (LSE: CAT). I first came across this biotech company just before Christmas, when it announced an agreement with Monsanto (NYSE: MTC). After commenting on that tie-up, if I'd quickly thought "Ah ha! Human monoclonal antibodies eh? I'm going to get a piece of that exciting action!" and immediately bought CAT shares, I would have paid about 550p.
Four months and a few announcements later, CAT shares now stand at 2525p, having touched 4975p in the interim. Excluding the bid-offer spread and dealing costs, shares in CAT have given a 459% return since Christmas. Wow!
Let's put that return into perspective using the Qualiport's investment ambitions as an example. The Foolish long-term buy and hold portfolio aims to achieve an average annual compound rate of return from its investments of 15%. It would take over 10 years for a 15% annual compounder to achieve CAT's recent performance.
Or instead, let's use Warren Buffett as a benchmark and his 30-year record of compounding his investments at 23% per annum. It would take Buffett over 7 years to achieve CAT's 459% return.
Given CAT's rate of return, if I had bought at Christmas, do you know what I'd be thinking right now? Something along the lines of "time to bank the profit". I mean, if I'm happy with a 23% annual return, I could put my profits in the bank and have 7 long years to consider the next purchase.
Basically, using the proposed long-term buy and hope strategy, I would have had no real idea of CAT's risks and potential before Christmas, and still have had no idea now. Has the long-term share price growth already arrived for CAT? They could become a future biotech titan, or equally become a huge failure. I don't know. But something I do know is that using the "hopeful" strategy could generate large and tempting short-term profits and so the long-term plan can go out of the window.
Are there any Long-Term Buy and Holds?
All this leads to me to question the merit of the long-term buy and hold philosophy. What's needed for a quintessential long-term growth stock is plenty of future revenue growth and a sustainable business advantage to keep the competition at bay. Great examples of growth stocks from yesteryear are Coca-Cola (NYSE: KO.) and Microsoft (Nasdaq: MSFT). But businesses in this league are few and far between.
There are only a relatively small number of growth industries that can cater for long-term buy and holders, good examples being media, software and telecommunications. Sectors such as general retailing, food producing, insurance or leisure have limited long-term growth prospects. Will there be much more demand for clothes, food, home contents cover or nightclubs in ten years time, as opposed to now? I don't think so.
These are mature markets and although some operators may come along and gradually increase their share of the industry pie, a company having a static-sized marketplace does not bode well for the long-term investor. Any growth concept in a moribund sector has foreseeable limitations and the stock market, knowing this fact, will always apply a relatively low rating to the company. And without a significant valuation re-rating, substantial long-term share price gains are difficult to attain.
The other point when contemplating a long-term investment is that most businesses don't have the necessary durable commercial advantage to succeed for the required decade or so. Call it the benefits of capitalism, but competition is all-pervasive. Most businesses, although they may operate in growth markets, just don't have any proven history to fend off future profit-hungry rivals.
You may have the best microchip, flat loudspeaker or Internet security software at the moment, but what's to stop somebody else designing something better? Will ARM Holdings (LSE: ARM), NXT (LSE: NTX) and Baltimore Technologies (LSE: BLM) still be top of their respective industry trees in ten years' time? The fact that most investors hadn't heard of those three companies five years ago gives some evidence of the fast-changing and slightly unpredictable nature of their future.
The exception rather than the rule
So to end, I consider most companies not to be true long-term investments. By and large, I feel investments fall into three groups. Firstly, there is the short-term "value play" category, a particular philosophy of which is described by TMFPyad in this feature. Secondly, there is the medium-term growth stock, or the company that has hit upon a growth concept within a mature industry and succumbs to the inevitable competition a two or three years down the track.
And thirdly, the "short-term" growth stock, or the company that has the potential to grow so fast in an emerging industry that the stock market quickly brings its long-term valuation to the here and now. And thus, with the rapid growth recognition, so the original long-term plan actually becomes a short-term holding. Good examples of this phenomenon would be ARM and Baltimore.
And just one final thought on the ambitious long-term buy and hold theory. As I mentioned earlier, the really big and consistent winners over the last ten to twenty years are few and far between. Glaxo Wellcome (LSE: GLXO), Sage (LSE: SGE), Coke and Microsoft are the stock market exceptions rather than the rule. Perhaps then, the long-term buy and hold strategy should be the exception, rather than the rule.
Your comments and thoughts can be directed to the Fool's Eye View board.
Related Links
• Long-Term Buy and Hope
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