The Case Against Buying Low And Selling High

Includes: CL, CLX, CVX, GIS, JNJ, MO, PEP, PG, XOM
by: The Conservative Income Investor

One of the most basic pieces of financial wisdom that you will ever hear is the adage to "buy low and sell high." Only an idiot would argue with that, right? Well, I'll step up to the plate and be that idiot, because I do think there is a case to be made for treating the accumulation of excellent blue-chip stocks (and relying on the long-term business performance of those firms, rather than changes in the valuation multiples) as a strategy that can hold its own with, and even beat, the performance of the S&P 500 over long periods of time.

From June 12, 1993 through June 12, 2013, the S&P 500 delivered total returns of 8.56% annually.

Let us review the performance of some of the usual suspects of blue-chip companies that are fertile ground for due diligence among investors that seek to acquire ownership stakes in excellent businesses.

From June 12, 1993 through June 12, 2013, Exxon (NYSE:XOM) delivered total returns of 11.81% annually.

From June 12, 1993 through June 12, 2013, Chevron (NYSE:CVX) delivered total returns of 12.57% annually.

From June 12, 1993 through June 12, 2013, Pepsi (NYSE:PEP) delivered total returns of 10.40% annually.

From June 12, 1993 through June 12, 2013, Colgate-Palmolive (NYSE:CL) delivered total returns of 14.48% annually.

From June 12, 1993 through June 12, 2013, Procter & Gamble (NYSE:PG) delivered total returns of 12.29% annually.

From June 12, 1993 through June 12, 2013, Clorox (NYSE:CLX) delivered total returns of 12.81% annually.

From June 12, 1993 through June 12, 2013, Altria (NYSE:MO) delivered total returns of 17.72% annually.

From June 12, 1993 through June 12, 2013, General Mills (NYSE:GIS) delivered total returns of 10.02% annually.

From June 12, 1993 through June 12, 2013, Johnson & Johnson (NYSE:JNJ) delivered total returns of 13.03% annually.

Each of these blue-chip companies outpaced the performance of the S&P 500 over the past two decades. What is interesting, though, is that investors in each of these companies could have had an opportunity to "sell high" over the past two decades.

In 1999, Johnson & Johnson's P/E ratio averaged 31.6x earnings. General Mills traded in the low 20x earnings range during the dotcom bubble years. Altria traded at over 20x earnings in 1998. Clorox traded at over 33x earnings in 1999. Procter & Gamble traded at over 30x earnings in 1998 and 1999. Colgate-Palmolive traded at 34x earnings in 1999. Pepsi traded at over 32x earnings in 1998. Chevron traded at 40x earnings in 1998. Exxon traded at 32x earnings in 1999.

Sure, if you could sell at those points and redeploy the capital effectively, you could have done quite well for yourself. But there is something to be said for buying an excellent company, and then holding on as long as that company remains excellent.

Even if you did not sell Colgate at 34x earnings in 1999, you still compounded your money nicely at over 14% annually for the past two decades. You crushed the performance of the S&P 500. You turned $10,000 into $149,000 over the past 20 years. It is hard to get upset about that just because you can identify other moments in time when you could have advantageously sold. You did just fine holding on to an excellent company and letting the underlying earnings growth of the firm propel your total returns.

The purpose of this article, and the data presented, is not to discourage you from practicing value investing. The price you pay for any holding will determine the total returns that you ultimately receive. That's important enough to say again. The price you pay for any stock will determine the total returns that you receive from your holding.

Instead, my purpose here is to keep in mind that it may not be necessary to sell your excellent businesses that appear somewhat overvalued at the current point in time. Yeah, Colgate is at over 23x earnings, and that appears above its historical P/E range. That may be a good enough reason not to buy. But that does not make it a good enough reason to sell. Colgate has been growing its earnings by 9.5% annually over the past decade, and it's expected to grow earnings by 10.5% on a currency neutral basis over the medium term. There aren't a whole lot of businesses on this earth you can own where you get low-risk earnings growth of 10% annually without having to do much thinking about it.

Charlie Munger and Marty Whitman have both correctly pointed out that there are certain firms out there with strong business records of allocating retained earnings intelligently. The implication of this is that there are certain blue-chip companies that reliably grow earnings per share by 8-12% annually over most rolling five- and 10-year periods. There are only four or five dozen blue chips you can make that statement about, and when you build a diversified collection of them, it can be lucrative to sit back and enjoy the ride of watching the earnings grow instead of worrying about how to take advantage of the selling opportunity that lies in front of you.

An added appeal of this approach is that it comes with a great psychic reward of watching something you bought grow year after year. It can be an easier way to live because you are not focused on the ticker tape changes of your businesses, but rather, you are electing to achieve total returns that roughly mirror the earnings growth of the company over long periods of time. There are no frictional expenses, such as selling fees and tax hits, if you adopt the ownership mentality of allowing long-term earnings growth to determine your total returns (rather than P/E changes).

The conventional wisdom is that you should try to buy low and sell high. But you can do just fine by "buying reasonable" and kicking back to enjoy the ride. Plenty of blue-chip companies, including the nine listed above, delivered total return performance in excess of the S&P 500 over the past 20 years. You could have "beaten the market" just by buying quality and kicking back to let time and earnings growth do their things. This is what happens when you treat a high-quality asset as something to cherish, rather than something to trade.

Disclosure: I am long XOM, PG, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.