The theory of “buy and hold” is premised on two major assumptions.
First, the company is a great company and continues to be great — there are no major changes in the value drivers and prospects of the company for the foreseeable future. Second, the investor bought the stock at an attractive discount to its intrinsic valuation (or “margin of safety” as Benjamin Graham would call it).
The biggest weakness of the buy and hold theory is that there is no explicit mention of exit — return of capital and upside beyond that to investors. Equity research analysts like to use the concept of a catalyst as a solution to this problem. They frequently identify catalysts in their writing, calling out for events that drive stock price towards their intrinsic value, as part of their analyses. I am a non-believer, when it comes to the idea of a catalyst. In my opinion, undervaluation itself is the best catalyst.
So, what is the right strategy? Combining the idea of buy and hold and dividend investing makes more intuitive sense. An investor buys a consistent dividend paying stock and holds it for a period of time to receive dividend income. Once the dividend investor has recovered his capital (or at least a substantial part of it) through dividend income (it could take many years depending on the dividend yield), he could then choose to either to continue to hold the stock to receive dividends or sell the stock for capital gains.
On the other hand, buying and holding a non-dividend paying stock for it to reach its “intrinsic valuation” could be a long fruitless wait, perpetuated by the fact that there are no dividends in between to tide the investor through. In the worst case scenario, the stock never reaches its “intrinsic” valuation or anywhere near, commonly referred to as a "value trap."
- High Yield Dividend Stocks in Gurus' Portfolio
- Top dividend stocks of Warren Buffett
- Top dividend stocks of George Soros