There’s always plenty of food for thought in Warren Buffett’s annual letter to the shareholders of his Berkshire Hathaway investment company.
This year, one of the things that caught my eye was a clarification he made on buy-and-hold investing. He wrote:
“Sometimes the comments of shareholders or media imply that we will own certain stocks ‘forever’ … But we have made no commitment that Berkshire will hold any of its marketable securities forever”.
He suggests confusion on this point may have arisen from a “too-casual reading” of a set of business principles — included in Berkshire’s own annual report since 1983 — which he thought would “help new shareholders understand our managerial approach”.
The principle in question states:
“Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash …”
The point Buffett has now clarified is that this principle applies only to businesses Berkshire owns (outright or with a controlling stake) and not to minority shareholdings (‘marketable securities’) in companies listed on the stock market. He emphasised that “we regard any marketable security as available for sale, however unlikely such a sale now seems”.
Is buy-and-hold dead?
I don’t believe Buffett’s pronouncement means buy-and-hold investors should abandon the strategy. For one thing, he’s held some stocks — Coca-Cola, for example — for an awfully long time. If a business continues to offer the prospect of returns that are acceptable to him, he might indeed hold “forever”.
Unless you take buy-and-hold literally — which Buffett doesn’t — buying a stock as if you were going to hold it forever isn’t incompatible with regarding it as available for sale. Circumstances may change at some point in the future and dictate that a sale is the most beneficial course of action to take.
When to sell
In my view, there are really only two reasons to sell a stock for a buy-and-hold investor.
The first is if a permanent loss of capital becomes a serious risk. A prime example would be a company that becomes overburdened with debt and cash flow problems to the extent that there’s a real possibility of bankruptcy. Indeed, this is the reason why Buffett generally avoids investing in companies with high levels of borrowings.
The second good reason for a buy-and-hold investor to sell a stock is if it becomes so manifestly overvalued that recycling profits into a more reasonably valued business makes clear sense.
Of course, in both cases, if you set the bar too low, you will end up trading stocks so frequently that you’ll rack up excessive trading costs, which will erode the benefits of buying great companies at reasonable prices and holding them for the long term.
Still sensible
It’s not always easy to assess whether a company’s level of debt and cash flow problems are a temporary issue or if they seriously threaten a permanent loss of capital. Similarly, it can be difficult to decide when a stock is truly overvalued.
Buffett may be highly adept at making fine judgements on these matters, but I would say that for the average private investor, unless you are wholly convinced that a business is in mortal danger or extremely overvalued, continuing to hold the stock is still a sensible policy.
