Many investors have been told that buy and hold does not work anymore. With almost everyone glued to screens streaming real-time quotes, news and charts and with so many institutional investors having extremely short term timeframes, one would certainly believe that buy and hold investing is a dinosaur strategy.
Over the past decade stock prices have been extremely volatile, which has led many to believe that short term trading is the answer. Even those who purchased shares in quality companies one decade ago such as Coca-Cola (KO) or Wal-Mart (WMT) didn’t perform better. The main reason for the low returns over the past decade was the fact that in the late 1990s investors forgot about fundamentals and bid up stock prices to unsustainable levels. The price/earnings ratio on the S&P 500 index increased to 30 times earnings, which was twice the average of the preceding eight decades. Thus investors were betting that earnings would keep increasing at a faster rate over the future.
The following stocks were overvalued in 2000. Yet these solid businesses still managed to grow earnings and distributions enough to make them attractive today:
For example Coca Cola (KO) ended at $60.94 in 2000. At that time the stock was trading at a price/earnings ratio of 69 and yielded 1.10%. Earnings per share increased almost 230% over the past decade, while dividends per share increased by 140%. Currently the stock trades at a price/earnings ratio of 18, while yielding 3.20%. (analysis)
Wal-Mart (WMT) ended at $53.13 in 2000. At that time the stock was trading at a price/earnings ratio of 44 and yielded 0.50%. Earnings per share increased almost 170% over the past decade, while dividends per share increased by 350%. Currently the stock trades at a price/earnings ratio of 13.50, while yielding 2.40%. (analysis)
McDonald's (MCD) ended at $34 in 2000. At that time the stock was trading at a price/earnings ratio of 23 and yielded 0.60%. Earnings per share increased almost 270% over the past decade, while dividends per share increased by 920%. Currently the stock trades at a price/earnings ratio of 16, while yielding 3.20%. (analysis)
Johnson & Johnson (JNJ) ended at $52.53 in 2000. At that time the stock was trading at a price/earnings ratio of 31 and yielded 1.20%. Earnings per share increased almost 170% over the past decade, while dividends per share increased by 210%. Currently the stock trades at a price/earnings ratio of 12, while yielding 3.70%. (analysis)
Automatic Data Processing (ADP) ended at $63.31 in 2000. At that time the stock was trading at a price/earnings ratio of 48 and yielded 0.65%. Earnings per share increased almost 100% over the past decade, while dividends per share increased by 280%. Currently the stock trades at a price/earnings ratio of 15.60, while yielding 3.30%. (analysis)
While stock prices were much overvalued at the beginning of the decade, some businesses managed to increase revenues and profits. The consistent increases in profitability have made many quality stocks that were overvalued in 2000 attractively valued. The only returns that buy and hold stock investors in those stocks generated came from dividends. This provided positive feedback to investors during two of the bear markets of the past decade. While yields were low due to the market being overvalued, quality companies kept raising dividends, which raised the yield on cost to original investors. If investors also managed to reinvest those dividends consistently, they would have been able to capitalize on any market weakness and further compound their dividend incomes in the process.
Despite the increasing noise in the markets, buy and hold investing does work. Investors who dismiss buy and hold investing altogether due to the poor performance over the past decade might be missing out on some great opportunities. Most of the quality dividend companies that were overvalued in 2000 are still quality businesses. Those businesses are attractively valued today, and yield much more than what they did in the year 2000. These businesses are also still growing, which means that investors should expect strong dividend growth in the future, which would increase their yield on cost. In addition to that, by reinvesting dividends, investors would be able to further compound their dividend income.
Full Disclosure: Long all stocks listed above
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