Book of Wise Investors

“There is a huge difference between the business that grows and requires lots of capital to do so and the business that grows and doesn’t require capital.”

When you hear mutual fund companies advising to buy and hold so that can reap the almost guaranteed returns from stock markets 40 years down the road, what they did not tell you is that their so called professional money managers actively engage in short term trading so that fund A can beat fund B in annual returns.

When should you really buy and hold on for a long time, almost forever?

It is obvious to most that not every stocks (or businesses) can buy and hold on forever, not even well known giants like Lehman Brothers. The key is the nature of the company behind.

The key difference behind whether companies that can hold on forever and one that do not is simply whether it needs significant capital to grow. The logic behind it is very simple. A business that requires huge capital to grow will eventually need to issue new equity, in addition to debt, to finance its operations. And that will unlikely to enable to let the stock grow in value in the long run.

Millions spend in research and development, changing product design and subsequently retooling means millions are unable to spend on expanding business in new markets, buy new and related businesses, or even buy back own stock to undiluted existing shareholders, in the end, unlikely to even declare dividends to shareholders.

Precisely the reason why Warren spend billions on Coca Cola instead of General Motors which by the way, now has filed for bankruptcy. Automobile companies in general have to constantly spend billions designing new models so that consumers will not buy some other better design from others. After introducing a new design, then need to spend some millions more on retooling the factories. This is in addition to earnings heavily affected during recessions, given the fact that a couple of recessions happen during each decade. In contrast, the same formula that produces coke did not change much between now and 100 years ago. People are also unlikely to give up drinking coke and smoking even during severe financial crisis.

It is highly unlikely that stocks will grow in value in the very long run if its business requires massive capital to grow, funds will just tied up somewhere else.

If a business does not require massive capital to grow like Coca Cola, retained earnings will just pile up and make both the management and shareholders rich.

As you can see, not every stock can grow in value if you hold on forever.

I’ll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It’s addictive. And there’s fantastic brand loyalty.

Related posts:

1. Are dividends yields a good measure of stocks value?
2. Why the stock markets are not efficient 100% of the time
3. Why the average stock investor is first class honor?
4. Look for certainty when investing in stocks