BI > DECEMBER 2002

Advantages of Long-Term Investing

"I Find Bear Markets the Most Interesting of Markets"

by Dennis Shepherd with Amy Rauch-Neilson

Q. How do you define long-term investing?

A. A book by Vic Sperandeo, Trader Vic: Methods of a Wall Street Master, comes to mind. I don't agree with a lot of things he has to say, but in that book he gives three very useful definitions: trading: a horizon of minutes to days; speculation: a horizon of days to months; and investing: a horizon of months to years. So picking up where Vic leaves off, I define long-term investing as investing over a horizon of three to five years.

Investing over a time horizon does not mean "holding." Just as traders trade on where they think the stock will be in 10 minutes or two days, long-term investors invest based on where they think the stock might be in three to five years or even longer.

For example, if investors buy XYZ company based on their estimation that it will triple its earnings in five years and 10 minutes later discover information that changes that estimate to a negative earnings growth and poor long-term outlook, they should not hesitate to turn right around and sell it.

Of course, that's an extreme example. More typically this might occur a few quarters after they have bought the stock. Long-term investing isn't the same as buy and hold for three to five years. It means buy or sell based on expectations of where the company will be in three to five years.

Q. What are the biggest challenges of becoming and staying a long-term investor and how does an investor overcome them?

A. I find the biggest challenge is to learn how to think for myself. A lot of people claim to be long-term investors, but then they always want to know why their stock isn't doing so well a week or two later.

Just last month I bought a small technology company in the low 30s, then again in the teens. On one of the NAIC forums, people constantly questioned me about why I would buy a stock when the price is going down. It takes a lot of strength to learn how to push aside the noise from friends and associates, especially from the ones you respect the most. That doesn't mean ignoring them. But you have to learn how to filter out the noise and take in the important information.

It took me many years to learn how to efficiently read about the companies I own and the ones I'm considering. I learned not to react to each piece of news, but rather to look at the news as a sort of landscape and to trust my experience and judgment in deciding over the long term just what impact the news has on the big picture.

Some people have knee-jerk reactions to each piece of news. Some people purposely avoid the media so as not to "get confused." I believe the answer lies somewhere in between.

Dennis Shepherd, who first joined NAIC after graduating from college in the early 1960s, has been both a club and individual investor. A resident of Owings, Md., Dennis can be reached at bayfishing@compuserve.com.

Q. Is coping with a bear market the worst of the challenges, as many people seem to think?

A. I find bear markets the most interesting of markets and, as a consequence, the most enjoyable. Bear markets became interesting rather than frightening because I learned over a long time that we need the occasional bear market to go bargain hunting. My best investments have always been the ones I bought during bear markets.

Just keep using NAIC tools to ferret out bargains that will make you feel really good during the next bull market. You can relieve yourself of a lot of stress if you learn to focus on individual companies and not the overall market or your portfolio's bottom line.

Q. What are the biggest advantages of long-term investing?

A. The biggest advantage of all is that you can save a lot of time and do other things besides invest. People can make money on the short horizon with a lot of effort and expense. But the dollars you get for your efforts are much smaller than what you achieve with long-term investing.

Long-term investing works well for three reasons. First, the competition is less severe and doesn't matter so much. The tools required are less expensive and sophisticated because the need for real-time, second-by-second information is greatly reduced, even eliminated.

Second, there is the long-term upward bias of the market. This upward bias is very insignificant over the short term but a very helpful factor over the long term.

Third, the mission is simpler. You don't have to worry about the overall market or investor psychology or parabolic curves. All you need to do is to make sure you are investing in solid, growing companies.

Q. Are there any advantages of long-term investing that people overlook?

A. I think Peter Lynch pointed out an advantage that most people overlook. In his first book, One Up on Wall Street, he says the individual investor has a huge advantage over the professional fund manager.

We think perhaps the fund managers have the advantage because they can have lunch with CEOs. But remember, they're trying to watch hundreds, sometimes thousands of companies all at the same time. If we focus on "what we know" and do this for a handful of firms, our overall results can be better than those of the pros.

Q. Any final words of advice on hanging in there for the long term?

A. I sometimes think long-term investors err on the conservative side. We may want to encourage newcomers to start out being very conservative, even pessimistic, and focus on worst-case scenarios so that they're not unpleasantly surprised by outcomes. But I think more-experienced NAIC members would benefit from learning how to free themselves from that kind of thinking once they have shed their investing training wheels.

I always cringe when I read on the CompuServe forum or I-Club-List a message from an experienced investor that says something like, "and after I finished putting together my SSG, I adjusted the 22-percent growth rate back to 15 percent just to be on the conservative side."

What concerns me is that this adjustment might cause the investor to miss an opportunity when comparing that stock with others. I think the only thing this kind of adjustment will accomplish is ensuring that less money will be made over the long term. I call this "opportunity loss."

The better behavior, in my opinion, is to say: "The Stock Selection Guide on this company has a 22-percent growth rate. Since few firms can sustain that over a period of about 15 years, I need to do further research to see whether this growth rate can be justified for my five-year projection. I need to find out whether this company is nearing its maturity point or is still in the sweet spot."

My advice is not to automatically cut back growth, but to use such high growth as a red flag to make you do more research and determine how sustainable the growth rate really is. If in the end you adjust the growth rate down, be sure to have specific reasons for making such an adjustment. Don't be cavalier about it.

Novice investors lose money by being too optimistic. Experienced investors probably lose more money by being too conservative than by being too optimistic. That's what experience is all about. It's a tool that helps you manage risk. So use it.