Education: Growth & Income Investing

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When You Should "Buy and Hold"

Your stock’s value is dropping faster than a lead balloon. However, you hang on tight in hopes of a rebound. After all, placing a sell order would mean throwing in the towel, waving the white flag…admitting that you are wrong. You are a buy-and-hold investor and this philosophy is time-tested and true.

A buy-and-hold strategy does not guarantee profits—no investment strategy can, especially in a bear market. However, contrary to countless articles written on the subject, buy and hold is not entirely dead. The key is to buy and hold until your company’s fundamentals start to go south. Then you abandon ship.

Know When to Hold ‘Em, Know When to Fold ‘Em

To buy and hold is perfectly acceptable. To hold forever without regard to fundamentals, because you are under the false notion that the approach is guaranteed to make money, is absolutely foolish. In this case I would have to agree, it is time to make the funeral arrangements.

Just ask anyone who had a vested interest in WorldCom. The company was considered by many to be a great buy-and-hold security. However, from June 30, 2000 to June 22, 2002, the company’s stock plummeted from $45.88 per share to $1.22. Think about the investor who picked up 100 shares at a cost of $4,588. In just two years, that same investor, who bought and held, would be left with around $100.

Even the world’s greatest stock pickers can make bad investment decisions. Sell rules MUST be part of any investment strategy—even a buy-and-hold approach. But how can one determine whether or not a company is worth holding for the long term?

One word—earnings.

Buy-and-hold investors should be on the hunt for companies that consistently report solid earnings, driving the share price higher. A company's ability to generate earnings from its investments is truly important for this type of investor. Earnings are the most tangible proof that a company is worth buying and holding for a longer period of time.

Importance of Earnings Estimate Revisions

A company that is receiving a steady stream of positive earnings revisions is moving in the right direction. This company most likely has a strong management team, a solid product line, a favorable competitive edge, etc., enabling it to grow earnings at a steady rate. A good long-term hold.

However, if this same company’s business conditions begin to weaken, leading to a series of negative earnings revisions, the buy-and-hold investor has to take notice. Once the company is assigned a Zacks Rank #4 or Zacks Rank #5, this should be a red flag and requires profit taking or cutting of losses. The stock is heading in the wrong direction; and it is time to part ways. When WorldCom sat at $45.88, its Zacks Rank slipped to a 4. It had a price of $29.94 when it became a Zacks Rank #5 stock. And we all know the rest of the story.

To longtime Zacks customers, you already know that “earnings estimate revisions are the most powerful force impacting stock prices”. And the best way to harness this phenomenon is through the Zacks Rank. (Learn more about the Zacks Rank).

Maximize the Performance of Your Portfolio

If you are like most stock investors, you probably dedicate a great majority of your time to finding buying opportunities. While this is obviously of great importance, if you are to succeed with a buy-and-hold approach, you need to stay on top of your portfolio and develop a set of sell rules as well. Those that take the buy-and-hold philosophy to the letter of the law are most likely doomed for failure. WorldCom serves as just one example.

Of course, the idea of hanging on to top-quality investments while dumping the dogs is great in theory, but it is definitely tough to put into practice. Have you ever heard the saying, "Even a dead cat will bounce if dropped from high enough!"? When the market temporarily rallies after a prolonged down period, only to then continue on its downward spiral, this is referred to in the investment community as the dead cat bounce. Don't fall victim to it—no pun intended.

The Portfolio Tracker, offered through Zacks.com, is an excellent tool that buy-and-hold investors can utilize. Read more about this powerful tool below along with our other products and services that can help maximize the performance of your portfolio.