Tuesday, March 3, 2015

What Matters in The Long Run

Here is a guest post from my friend Adrian Lane that shows what long term time horizons can do, how they massively overweight any other single advantage, and a lesson on when to sell:

"In the 1990s, working in tech during the great Internet surge, cash flow was good. My wife and I decided to begin investing some of the extra money we earned at the end of each quarter. We started with small sums of $500 here, $1000 there. 

In 1997 we bought a handful of shares in Home Depot (HD). We purchased shares just after the 1997 split so, which means we saw the stock split in 1998, and again in 1999, rolling the small number of shares into a larger number. When the tech collapse occurred, we stopped investing, and pretty much forgot about those investments, knowing full well one or two had failed outright. 

Now that we have 18 years under our belt, it’s fun to look back and see where we are, and HD is one of the highlights. Price adjusted for the two subsequent splits - our original investment was about $11/share. At the moment I am writing this HD is trading for $116/share price, with a 1.67% yield. My yield on cost - meaning yield compared to what I paid originally, is ~ 52%. HD announced a significant dividend hike for the next round of payouts on March 26, 2015. My new yield on cost will be ~61%!  That’s what 18 years and a quality stock will get you. 

My friend Gunnar said: 'Great story. Great illustration of massive power of time and quality. '

To which I said yes, but there is a more important lesson I have learned from this. 

When the stock hit 76 a share I thought it had run it’s course. Told my wife I was going to sell it. When looking at the fundamentals of the business on paper it looked like it had run out of steam and was due for a long period of inactivity. How on earth with new construction slowed and baby boomers not able to update their homes is HD going to continue to defy gravity? She said ‘No’. This was about the time I read the Buffett’s answer to the question “Ideally, how long do you hold a stock” - “Indefinitely”. So I agreed with her.  

At first I thought I was right as it muddled between $74 and $82/share for 18 months. Then it shot forward again. Now it’s doubled in value if you consider stock price and dividend combined. It’s still the same quality business it has always been and it continues to grow. At this rate,  before the end of this decade, it will pay me back my original investment in dividend every year. 

So my lesson was "If there is nothing fundamentally wrong with the business, DON”T FREAKING SELL IT".

I don't have much to add, this post says it all very well, but the one thing I would say is that one reason that I find quality income investing so effective is that even at the end of this terrific performance by Home Depot - it's still worth holding, the business is as strong as ever. If you compare that to a growth stock where you get it right, you then have to sell and find another good one. You have to be right twice (or more). With a quality income stock, you only need to be right once and then let the company do the work.


  1. If the current yield is 1.67%. Would it not be better to sell and reinvest the funds in a company with a higher yield?

  2. @Paul - its a good question, and no doubt there are some stocks that could appear better buys than HD. As you say, in theory it should not matter.

    A couple of points to consider, I do not own HD, but I think there are not *that* many stocks that are that much better. If you look at HD's year in year out margins, ROE, dividend growth and other metrics its hard to find a ton of stocks that can beat it. This matters because its not worth finding a company that is say 10% better because if you are a long term holder then you would incur a lot of taxes. The main star of this story is the effect of compounding and selling/taxes gets in the way of compounding so at least in my opinion selling for something as good as or even slightly better than would not make much sense on its own. I would probably want something more like 50% better value with similar long run compounding characteristics and I think that is probably a short list. Of course, everyone's situation is different and this is not guidance, but that is how I would tend to think about it.

  3. You also need to do the math on what amount you have to reinvest after paying taxes. The bigger the capital gains, the better the new investment needs to be.