Value investing is a process that aims to deliver outstanding long term returns. However, this should not be confused with the notion that value investors tend to buy and hold stocks for the long term. Buy and hold strategy ignores valuations over the holding period.
Many consider Warren Buffett as a great example of a successful value investor and Mr Buffett does ask the question if he will be comfortable holding a company for decades before he decides on making an investment in the stock. However, this is merely to ensure that the company he is considering investing in has quality of earnings and a sustainable competitive advantage that will confer a level of safety should something unpredictable occur in the future. Please note that even Mr Buffett will exit a position quickly (or as quickly as the liquidity allows) if he determines that the investment no longer has a merit.
Value Investing is Essentially a Timing Exercise
It is not market timing in the sense most of us understand. Value investors choose to buy a stock when it is cheaper than the intrinsic value of the stock and sell it when it becomes more expensive. How is this different from market timing? Consider this hypothetical example.
A company can come out with a news that could not have been predicted. The same stock that was overvalued at a given price, may suddenly become undervalued AT THE SAME PRICE. A new joint venture, FDA approval when the expectation was more delays, striking gold, whatever. Reverse may be true as well. A value investor tries to “time” the value of the company, whereas a market timer will completely miss this development as it is not something he is concerned with.
It Gets Stranger: A Value Investor Might Sell a Stock that is Still Undervalued
The chief aim in value investing is to put as much distance between the stock price and the intrinsic value. Cheaper the stock price the better. Sometimes it happens that the investor might find a stock that is even greater value than the stocks he currently has in the portfolio. In essence, this new stock offers greater potential rewards at a greater margin of safety (meaning less risk). No value investor worth his salt will let this opportunity pass. If this means selling an existing holding that is relatively fully valued, then so be it.
Closely watch a value investors portfolio and you will find stocks come in and stocks go out quite frequently. At least more frequently then you will expect to see in a buy and hold portfolio. I have personally averaged 1-3 transactions per month in the last few months, but there have been months when not a single transaction was made and then there have been times when 4-5 transactions were done in a week. It all depends on the opportunities.
Is there a Place for Buy and Hold in a Value Investor’s Portfolio?
Could be. There may be rare companies that continue to grow value at a rapid clip. These are the companies with a competitive moat. Still, the primary function of a value investor is efficient capital allocation, and short of tax considerations (especially for large capital gains), it is hard to make an argument for staying with an investment if a better opportunity exists.