It seems like everyone in the financial media pays lip service to long-term investing and long-term investments. I've actually heard some folks say they are "long-term investors" because they held a stock for 6 to 12 months! That is delusional thinking. Can you imagine buying an office building or acquiring a patent to make money from the license rights for that short of a timeframe? Of course not.
A long-term investment is, at minimum, one held for at least 5 years and, more appropriately, one held for 10 years or longer. Over a decade period, a business is likely to reflect the underlying operating performance and trade around a rational range of its true business valuation, or intrinsic value as it is often called.
The Test We Use to Determine If We Are Making a Long-Term Investment
For my own family's long-term blue chip stock holdings both personally and through our businesses, we employ a handful of checklist items to determine if we are thinking as business owners hoping to profit from the success of a good company. We ask ourselves the following questions:
- Do you believe that 10 years from now, the company will be earning far more money in real, inflation-adjusted dollars?
- Do you believe that the company will provide you the opportunity over the next 10 years or more to cash a lot of dividend checks that can be spent, reinvested, or given to charity?
- Are you able to buy ownership in the company at a reasonable price?
- Can you resolve not to touch the money for the next 10 years once you’ve made your investment?
- Can you hold the shares through a tax-advantaged account, plan, or entity to reduce the cut the government takes of the wealth your investment generates?
If you go through life making decisions like this, it isn't hard to see how someday you wake up with passive income that has skyrocketed, throwing off cash for you to spend, invest, give to charity, or save for the future. In less than a year, I'll turn 30 years old, yet I'm still collecting dividends on shares of stock that I bought as a teenager.
Not Every Investment Should Be a Long-Term One
This does not mean I believe every investment should be a long-term one. There are different types of companies, such as cyclical steel manufacturers, that just aren't appropriate to own on a buy-and-hold basis. I wrote extensively about my experience with one such business on my personal blog and, many years ago, wrote an essay on this site about how the intrinsic value calculation for a cyclical business is necessarily very different using the writings of Benjamin Graham as a reference.
In other words, you cannot and should not "buy and forget", a lesson that shareholders of Eastman Kodak have learned the hard way. You need to take the time to review a company's annual report and 10K documents each year, re-pose the questions from the above checklist, and try to figure out if the company will still be profitable in the future.
The Rewards from Long-Term Investing Can Be Fantastic
In the end, long-term investing is worth the time and effort because it allows you, in the words of billionaire Charlie Munger, to "sit on your ass" and grow richer as time passes. Consider the twenty-year case study of consumer giant Procter & Gamble. Had you put $100,000 into the stock in 1991, by the time 2011 rolled around, you would have been sitting on 14,535 shares of P&G worth $938,670 plus you would have collected $243,461 in cash dividends along the way! That is a grand total of $1,182,131. It could have been higher if you had reinvested those dividends into other stocks, bonds, mutual funds, or real estate.
The story is nearly the same for another blue chip giant, Colgate-Palmolive. Had you put $100,000 into it back in 1991, by 2011, you'd be sitting on $890,100 worth of stock plus have amassed $168,200 in cash dividends over the years.
Traits That Tend to Make for a Good Long-Term Investment
Good long-term investments often, but not always, have a few common characteristics.
- Simple products or services that are easy to understand
- Strong competitive market positions protected by trademarks, patents, and copyrights
- Low cost operating structures
- Inexpensive items that don't attract a lot of attention, such as laundry detergent or cola
- Management that has a long-term outlook, only paying dividends, repurchasing stock, or expanding when it is in the best 10+ year interest of the firm
- Boring sector that no one pays attention to or discusses at cocktail parties
- Some sort of inflation protection, mainly in the ability to raise prices, while requiring very little reinvested capital (which is another way of saying high returns on equity with little or no debt).
Though the list is far from expansive, it is a good place to start if you are striving to put together a collection of high quality, blue chip holdings. For more information on the types of businesses that you should be looking for, read Getting Rich By Investing in an Excellent Business.
