Most investors focus far too much on the short-term. They look at how a company has performed in the last year, and they look at its share price movements over the past few weeks or months. They’ll read the news, follow the latest updates and then move in or out of shares based on what they think will happen in the months ahead.
Unfortunately, most investors underperform the market by several percentage points a year, and short-term investing is one of the major culprits. To be better than average, you have to do something different, and one key difference is to take a long-term view.
Long-term investing is a key component of some of the most famous and successful investors of the last century. It separates those who run around in circles like headless chickens from those who understand the timescales in which business and stock market cycles work.
Have long-term goals
Long-term investing starts with having long-term goals. Although most investors focus on the short-term, they’re usually working towards a long-term goal. In most cases, it’s a pension, and a pension is always a long-term commitment.
When you’re building up a pension nest egg, it typically takes decades, and when you finally get around to drawing some income from it, you want the income to last for decades too.
Investing is a multi-decade event. Don’t set goals for this week, this month or even this year. Think about 5, 10 or even 20 or more years into the future.
One consequence of thinking about the long-term is that you might want to take less risk. After all, a stock never comes back from zero, and money lost that way can never be regained. Successful and defensive companies that have already existed for decades are often the investment vehicle of choice for long-term investors.
Analyse a company’s long-term past
Long-term investing should impact your investment analysis.
If you want to be a long-term investor, then next time you’re reviewing a company, don’t just look at what it’s done in the latest annual report; look back further, much further. Go and dig up 10 years of annual reports and flick through them. Get a picture of what the company has done over many years.
Those investors who are willing to go the extra mile and review many years of financial and operational information are the ones who are more likely to uncover long-term winners.
Long-term winners are those companies that can make profits year after year after year. They might have the odd blip, but in the long run, they usually bounce back and keep on growing faster than inflation, rewarding investors with a progressively increasing dividend.
Of course, it’s not all sweetness and light – the stock market is a risky place, and bad things can happen to good companies, but if a company hasn’t had a long run of success in the past, then it’s less likely to be able to produce one in the future.
Hold investments for the long term
Long-term investing also applies to the expected holding period for each individual investment. The average holding period these days is less than a year which is just shocking.
Over a period of less than a year, most of your returns will come from movements in a company’s share price rather than from dividends.
The problem is that share price movements in the short term are driven by Mr. Market’s sentiment towards a company, and that, in turn, is driven by news. News is random by definition (if we knew what was coming, it wouldn’t be news), and so share price movements in the short term are random and unpredictable.
These random and unpredictable share price movements are just as likely to be downward as they are upward, and so over these timescales, investing becomes little more than a trip to the casino.
No wonder most people don’t trust the stock market because so many investors are little more than speculators and gamblers.
It’s only over time scales of 5 years or more when dividends and fundamental changes to individual companies begin to outweigh the random and unpredictable mood swings of Mr. Market.
In 5 years, you can easily get 30% or more from dividends. If a share’s dividend yield was 5% to start with, and if that dividend grew every year, then it would be unlikely that the share price would fall enough to negate those gains.
Similarly, in 5 years, there are many companies that can grow their operations by 30-50%. If the revenues, profits and dividends of a company go up by that much, then it’s very unlikely that the shares will go down over those 5 years (assuming the starting share price was even remotely close to fair value).
Apply the lessons of long-term investing
The lessons of long-term investing are everywhere, and yet so few people want to take them up, which makes it all the better for the few who are making the leap.
- If you want more reliable income, focus on the long-term.
- If you want companies that can consistently grow for years, focus on the long term.
- If you want companies that are low risk and can survive the ups and downs of business and economic cycles, focus on the long-term.
- If you want to get a reliable measure of a company’s value, focus on the long-term.
Next time you’re reviewing a company, look at ten years of its history and ask these important investment questions:
- How has it changed in that time?
- Does it make more money than it did ten years ago?
- Has it been a steady ride or a roller coaster?
- How much has its industry changed?
Then think about the next ten years:
- Could the industry change dramatically?
- How likely is it that the company will be bigger ten years from now than it is today?
- Could it go bust within that time?
Only after looking at the long-term should you think about the company’s results this year. And when you do think about this year’s results, think of them as just one set of annual results out of the many you could see during your years of ownership (if you buy the shares, of course).
Long-term investment success requires long-term thinking, which means looking back at how a company has performed over the last ten years and then thinking forwards to where it might be ten years from now.
It also means occasionally thinking about where your portfolio is heading and where you want it to be 10, 20 or 30 years from now.
The quote below is almost 100 years old, but it is just as insightful today as it was back then:
“The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.”
– John Maynard Keynes, 1935
Hi John,
Great advice and agree with everything you say.
You may recall me questioning your sale of Reckitt back in April and you said in response “I think holding RB will work out to be a good idea, but buy-and-hold isn’t my style” so just a little confused as this seems contradictory?
Thanks for any clarification.
Best,
John
Hi DIY, yes I see that it could look contradictory.
The point is that investors should think long-term about their portfolios. Then they should think about the long-term past and future of the companies that they are looking at. They should also expect to hold those companies for many years. However, that doesn’t mean that they must hold those companies for many years.
For example, if a company’s shares double in price, but the operational output of the company (revenues, profits and dividends) are little changed, then selling those shares may well be the most sensible thing to do. The money could be reinvested elsewhere for far better yields.
Even in that case long-term thinking applies. In the case of an overvalued company I would be thinking about where the shares could reasonably be priced say 5 years from now. It may be that even if the company doubles its operational output in that time, the shares may not move because they started out at a lofty valuation, if you see what I mean.
So selling on the back of rapid and possibly short-term gains (the Reckitt Benckiser example) can be a rational consequence of thinking about long-term likely valuations.
… and maybe you also consider the relative strength of the alternative long term investment opportunities available at the time?
Hi Ric, yes thanks for making that point.
One of my central ideas is there is no such thing as intrinsic value, but only relative value. An investment should provide a rate of return greater than the opportunity cost of capital, and the opportunity set depends on what else is out there.
So imagine the scenario where RB shares had stayed flat, or let’s say they fell by 10% while the company grew by 10%. Then in that case from an intrinsic value point of view the shares are better value and you might want to add to your existing position.
But if the shares of some other company, which was effectively identical to RB, fell by 50% to the point where they were clearly better value than RB, then it would be rational to sell RB and buy the other company (ignoring the myriad of other influences in the real world) because the other company’s shares would represent significantly better value for money.
So thinking about the long-term doesn’t necessarily mean holding every investment for the long-term, it means looking at the long-term factors of each company and perhaps taking advantage of short-term price moves either in the companies you own (selling when they go up) or other target companies (buying when they go down).