There is a lot to be said for laziness, especially when it comes to investing. The billionaire Warren Buffett, who’s seen a stock or two in his time, is fond of saying that most small investors are far too active for their own good. He suggests that most of us would do much better if we thought of ourselves as having a lifetime 20-stock punch card. Every time you buy a stock, you would punch out another hole in your card. After your 20th stock purchase, you would be finished. No more stocks. Ever.
Buffett’s punch card suggestion is all about the virtues of doing nothing. Most of us sabotage ourselves with too much trading. We listen to rumors, change our minds, jump in and out of stocks — at just the wrong times. Terrance Odean, a professor at the University of California at Berkeley, has traced the trading records of thousands of small investors and discovered that nearly all of us tend to buy stocks when they’re expensive (think back to 2006 and 2007) and sell them when they’re cheap (like last year). That, of course, is precisely the wrong way to make money.
Odean’s research suggests that many of us could boost our results simply by resisting the temptation to ditch lacklustre stocks in favor of hotter names. One of his research projects tracked people who sold stocks and then immediately turned around and bought other stocks. These people presumably thought they were dumping losers in favor of winners. But that’s not the way things worked out in practice. The stocks that the investors dumped went on to perform about 3.6 percentage points better over the next two years than the stocks they bought. Assuming that these results are typical, it would seem that most of us could bump up our returns from, say, 5% a year to nearly 9% simply by learning to buy and hold a few quality stocks.
Buffett follows exactly that approach. He has held many of his core holdings — the Washington Post Co., Coca-Cola, American Express and Geico — for decades. “Our favorite holding period is forever,” he avers.
But which stocks today are Buffett-like keepers? In this 10th anniversary issue of MoneySense we thought it would be fun to look ahead and attempt to pick 10 stocks that we think will be great buy-and-hold investments for the decade ahead.
We warn you that this is a dangerous exercise. Fortune magazine attempted a similar story in 2000. Out of the 10 “buy-and-forget” stocks it selected, only one (Genentech) proved to be a winner. Two of Fortune’s picks (Enron and Nortel) went bust. Many others (Broadcom, Nokia and Charles Schwab) are trading at a fraction of their 2000 price. The decade isn’t quite up yet, but it looks as if Fortune’s can’t-miss picks from nine years ago would have lost you about half of your money.
We wanted to avoid a repeat of Fortune’s experience, so we tried to learn a few lessons by observing where that esteemed publication went off the rails. Three observations:
• Fortune’s list of stocks to love was insanely expensive. Sure, 2000 was a giddy time for the stock market, but what were those Fortune writers smoking? The average price-to-earnings ratio of their picks was 100, as compared to a more normal ratio of 15 or so.
• Fortune assumed that current trends would continue pretty much forever, so it picked the current hot sectors and looked for the hottest companies in each of them: Nokia in cell phones, Viacom in broadcasting, Morgan Stanley in investment banking, Oracle in communications software, and so on. It appears that Fortune’s stock pickers never pondered the chance that these sectors might cool off.
• Fortune bet all its money on only four trends: networking, entertainment, the “boomerization” of financial services, and biotech. It did not diversify widely and it ignored the stodgy, old-fashioned sectors, such as banking, retail or consumer goods, that make up most of the economy.
In constructing our list, we started by reversing these three mistakes. We looked for cheap companies trading for 15 times earnings or less. We picked stocks that operate in some of the market’s coldest areas. We tilted things in favor of easy-to-understand businesses. We searched for companies that make or do things that people need every day or companies that, in some way, are essential to the economy.
Our research put a dent in some of our preconceptions. For instance, we had initially thought that our list of 10 can’t-miss investments would include several oil and gas companies. And why not? Just about every talking head on the TV screen appears to think that the world is facing an energy crisis.
Perhaps the talking heads are right, but after a lot of reading, we’re not so sure. Energy prices move in booms and busts. People have worried for half a century that the world will run out of oil — and so far oil is still flowing in vast quantities. In fact, the ratio of global oil reserves to current production has gone up. Back in the mid-1970s, the industry estimated the world had only 26 years of oil reserves at then-prevailing rates of production. By 2005, the ratio had soared to at least 40 years’ worth of production.
Most of the hysteria around oil centres on the Hubbert’s peak hypothesis, which holds that the world is at or near its peak oil production. The peak oil zealots may be right, but even if it is true that we are at our oil-producing peak, we still have decades left of gradually declining production. And it’s not by any means sure that we are at Hubbert’s peak. The date for the peak has been continuously revised over the years. M. King Hubbert, the geophysicist who invented the hypothesis, originally estimated that global oil production would top out between 1993 and 2000. In fact, global oil production in 2005 was 23% above the 1993 level.
There is no indication that the world is facing any shortage of natural gas either. Only three years ago, alarmists fretted that the U.S. was running out of the stuff. Then came massive new discoveries in the Barnett Shale of Texas and the Haynesville Shale of Louisiana. The industry now reckons that the U.S. has a reserve of natural gas equal to nearly 100 years of current usage.
What is an investor to make of all this? We acknowledge that oil and gas prices may soar over the next decade, but we think that they could equally well sink or plateau. There is no way to tell. By all means, invest in oil and gas companies if you want a well-diversified portfolio; just don’t think these firms are a sure ticket to riches.
More certain profits are to be had in other sectors. As we’ve already noted, we like cheap companies, in less than glamorous industries, that make money by providing everyday goods and services. Beyond that, our research led us to favor companies with a global reach (because emerging markets will provide much of the globe’s growth) and ones that can pass along price increases (because the amount of fiscal stimulus that governments are forcing into the system may well lead to a renewed outburst of inflation). Since debt is a major reason for corporate failure, we favored firms with as little of it as possible. We tried to select companies with entrenched market positions and substantial barriers to competition. And since consumer wallets may be rather tight over the next few years, we looked for firms that offer essential services or that can benefit from government spending.
These 10 stocks made our list of buy-and-hold investments for the decade ahead. (All prices are as of May 1.) Do your own research before buying and make sure nothing has changed since the time of writing.
Boeing (NYSE:BA, $41.50 U.S.) has taken a tumble over the past year and now trades for less than half its 52-week high. We think its plunge is a classic example of short-term thinking. However the future unfolds, rest assured that the world will need plenty of planes. Boeing is one of only a handful of companies that have the size and expertise to deliver the next generation of commercial jets. It can also count on landing a steady stream of defence contracts. Yet this essential firm trades for only 14 times earnings. It also pays a 4.2% dividend.
Cemex (NYSE:CX, $7.89 U.S.) makes cement. That’s it. Pretty exciting, huh? The Mexican company has operations that span the world and its stock price has collapsed in line with the global recession. But while construction projects are on hold for now, we don’t think the world has declared a permanent end to its need for cement. When growth does resume, Cemex should be highly profitable once again. Right now, you can buy the company’s stock for less than half of book value and under five times trailing earnings. That’s cheap, cheap, cheap. One caveat: this company has a large amount of debt, which it will have to renegotiate over the next couple of years.
eBay (NASDAQ:EBAY, $16.60 U.S.) continues to dominate the market for online garage sales despite competition from the likes of Amazon. It has essentially no debt and trades for less than 13 times trailing earnings. Its PayPal unit, a system for handling online payments, is growing fast and now generates over 30% of eBay’s revenues. The danger here is that management has a record of making some less-than-brilliant acquisitions. (Remember Skype?) But assuming that management concentrates on defending and building its core businesses, we love eBay’s prospects for the decade ahead.
Fairfax Financial (TSX:FFH, $321) is cheap. It trades for less than four times its trailing earnings and less than book value. Just as important, this Toronto insurance company is a great asset allocator and a fantastic value investor. Prem Watsa, its leader, was one of the few investors to bet against the housing bubble. He made billions by buying credit default swaps that would rise in value as other companies’ creditworthiness deteriorated. These days Fairfax is expanding globally, with subsidiaries in Asia and central Europe. While insurance is a cutthroat business, we think Fairfax’s investing expertise will set it apart from the pack.
Leucadia National (NYSE:LUK, $21.65 U.S.) operates a bit like a small town junk shop. It buys a bit of this, a bit of that. It fixes the stuff up and resells it. The strategy isn’t complex, but it’s immensely profitable if you’re a good judge of value. Ian Cumming and Joe Steinberg, who have been running Leucadia since 1978, appear to be excellent judges. Their record of investor returns is actually slightly better than Warren Buffett’s. But their sprawling empire — which encompasses everything from iron mining to wineries to biotech — has had a rough year and Leucadia’s shares have fallen to less than half their 52-week high. We think that means it’s time to buy. No matter how the world unfolds over the next decade, we suspect Cumming and Steinberg will find a way to prosper.
Johnson & Johnson (NYSE:JNJ, $52.59 U.S.) is the classic widows-and-orphans’ stock. The huge health-care company spans the globe and operates in markets ranging from medical equipment to skin care. It is a financial fortress, with little debt, steadily growing revenues and the ability to profit from the world’s growing desire for health and beauty products. It trades for less than 12 times earnings and pays a dividend of 3.7%. Boring? Probably. But we think that boring might do very well in the decade ahead.
Microsoft (NASDAQ:MSFT, $20.24 U.S.) has lots of flaws. Let us list some of them for you. It’s a software giant that doesn’t make industry-leading software anymore. It’s hopelessly unhip. It has yet to come up with a convincing online strategy. And so on. But you know what? This is also a company that has zero debt, that has doubled its net income over the past four years, and that trades for under 12 times earnings. We think there’s life left in the machine that Bill Gates built. And at this price, it doesn’t cost much to go along for the ride.
Service Corp. International (NYSE:SCI, $4.48 U.S.) makes its money from death. The Houston company operates funeral homes and cemeteries in the U.S., Canada and Germany. Given the greying demographics of much of the developed world, we are confident that the funeral business will enjoy steady growth over the next decade. While Service Corp. has more debt than we wouldlike, it trades for around book value and only 12 times earnings. It also pays a 3.6% dividend.
TransCanada (TSX:TRP, $30.25) performs two essential tasks: it generates electricity and it transports natural gas via its pipelines. We think both industries will do well over the decade ahead as power needs continue to grow and natural gas becomes a bigger part of the North American energy mix. TransCanada is no growth stock, but the Calgary company could be a surprisingly rewarding performer, given that it’s trading nearly 25% below its 52-week high. A dividend yield of 5% gives you plenty of reason to stick around and find out what lies ahead.
Wal-Mart (NYSE:WMT, $50 U.S.) is hated by unions. And it doesn’t get much love from Wall Street, which considers it too big to grow fast. But what company is better suited to the grind of the current economy? The world’s biggest retailer is the master at delivering low-priced merchandise to budget-hugging consumers. While other storekeepers staggered through the past year, Wal-Mart grew its earnings per share at a 6% annual clip amid one of the worst retailing climates in history. It may be nearing its limits to growth in the U.S. and Canada, but it still has lots of room to expand in China, India, Japan and Latin America. It trades for only 15 times earnings.