After reading a post on The Div-Net, I started to think about how I differ from dividend investors and why. The first point to make is that I’m not a dividend investor, in fact I consider myself a trader rather than an investor. An investor to me is someone who buys something with no explicit intention to sell it. This typically means they are either buying it for the income (dividend investors, landlords, Warren Buffett etc) or perhaps they are buying it to let the capital appreciate for decades or to let the kids inherit.
So why would I trade rather than invest? Well, there is some evidence that the returns are better if it’s done properly (which I’ll try to cover at some point), and more importantly it’s a better fit with my personality.
Since I’m buying with the intention to sell, how long do I expect to hold my stock?
It usually doesn’t take long for someone reading up on value investing to realise that it’s usually a long term game. As Ben Graham said in The Intelligent Investor:
The fact that both the favorable and unfavorable situations are part of any normal long-term picture (and as a consequence both should be accepted without undue excitement) is evidently not part of the stock market’s philosophy. The latter seems to be grounded on the feeling that, since nothing is really permanemt, it is logical enough to treat the temporary as if it were going to be parmanent – even though we know it is not.
So the stock market’s view is short-term, the next few quarters or perhaps a year. Current earnings are bad, a new competitor has arrived, the CEO has quit, etc etc. Mr Market is depressed about the company and wants to get shot of it now since it is unlikely to produce a good return, and may even go down further, in the next six to twelve months. The intelligent investor steps in, happy to buy such a ‘poor’ investment. How long will it be before things start looking up and Mr Market is knocking on our door offering a fair price for the company?
One study that does much to show how value shares outperform over a longer time horizon, but perhaps even more importantly, that they do not usually outperform over short time horizons and may even underperform in the months after your purchase, is Time and the Payoff to Value Investing. This study of South African value stocks splits the market by current P/E (a poor but easy to use measure of value) and holds the various portfolios for periods from six to thirty months.
The graphs clearly show how there is no meaningful difference in performance between the high and low P/E stocks within a six month timeframe. But by eighteen months the expected returns of low P/E stocks are clearly better. Their Figure 2 shows how the lowest 10% of stocks by P/E, over a 30 month period, outperform the average of their sample on an annualised basis by about 20%. That’s 20% annualised outperformance. Of course the standard deviation is higher but I (like many Grahamites) don’t use that as a measure of risk; perhaps the subject of another post.
Looking at my own Trade History, my average holding period has been 199 days. Somewhat shorter than a year, but that’s probably largely to do with the huge bounce in FTSE shares since March 2009. On top of that I’m still holding several companies which I bought in late 2008, where the holding period is now approaching eighteen months.
So next time I buy into a company, only to see if fall, and fall, for months on end, and then for it to flounder somewhere slightly below where I bought it for a year or more, I can look back at this article to assure myself that the odds are on my side and to quit worrying. That’s the theory at least.