Modified Buy and Hold pt 2

Investment Analysis Clubs Saul’s Investing Discussions
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Today I was talking to a friend who’s been getting interested in investing and I just opined: “Wow, Square is getting expensive!” He rightly responded, “You don’t think it could be worth far more one day?” I said, “Wow, good point. I didn’t mean that at all. I just meant that the PS is high at present. I could definitely see Square someday being worth several times what it is today.”

A year and a half ago I wrote a post summarizing Saul’s “Modified Buy and Hold” (MB&H) approach: http://discussion.fool.com/modified-buy-and-hold-32203068.aspx

Please don’t scrutinize it too closely. As mnadel pointed out, my percentage numbers were off (I underestimated). But the idea was that MB&H is simply about considering the short term AND the long term. My conversation this morning got me thinking, is it time to trim Square (which grew at 41% last quarter and has a PS ratio of ~16) and add to something in my portfolio that’s “cheaper?” The idea is that if growth is steady, something cheaper might have more room to run.

Growth rate: The key to modified buy and hold

Square grew adjusted revenue at 39% in the March quarter. In the June quarter that ticked up to 41%? A trend? This may come back to make me look stupid, but I’m going to way out on a limb and say that for the September quarter I expect them to grow revenue at 45%. Why? http://discussion.fool.com/would-you-be-interested-32798819.aspx…

Square literally has a segment that is growing faster than Shopify! And last quarter it was almost 25% of adjusted revenue. This is a tail that can definitely wag the dog.

But back to MB&H, I think this is a huge factor. 40% growth is super. Does it mean the company’s PS ratio should be 16? Probably not. There are several companies growing at that rate trading with PS at more like 9 or 10. HOWEVER, if that growth rate is increasing…look out. Square’s services business is one reason I believe growth rate is increasing. They’ve also been adding a ton of new things, and adoption by merchants has been great too. There’s good reason to think they’ll grow even faster than they have been…and do it for some time.

Does that mean the PS should be 16? 20? 13.75? Who knows. I just believe it will be a good bit lower after earnings come out on 11/8, because I believe Square’s growth is accelerating. And I think that’s an important concept to grasp with MB&H.

Bear
who didn’t trim Square today

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Hi Bear-

I’ve got SQ at a P/S of about 6.5. 13B market cap/ 2 B in sales for this year. Are you using a modified P/S ratio?

Thanks,
Jimbo

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Sometimes it’s good to be flexible and not be so stubborn when things change.

Change is difficult and admitting you were wrong is extremely hard.

2 years ago, Saul’s top 4 stocks, which nearly made up 50% of his portfolio were CELG, SKX, SWKS, and BOFI.

If Saul just stood pat and “bought and held”, ignored all of the changes, his portfolio results would be no where close to what it is now…

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I’ve got SQ at a P/S of about 6.5. 13B market cap/ 2 B in sales for this year. Are you using a modified P/S ratio?

Jimbo,

I’m using adjusted revenue. 814M for the TTM period.

Bear

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Square literally has a segment that is growing faster than Shopify!

Anecdotally, I was in the Charlottesville, VA area this past week and, being a long-time wino, decided to spend a few days visiting wineries. It had been almost two years since I last did a “tour” and this time, almost without exception, the tasting rooms were using Square.

What I realized was that besides the obvious benefits of business integration and ease of use, the tipping function had to be an incentive to otherwise poorly paid (“I do it because I love this place”) servers. I know I rarely thought about tipping the tasting room worker before, but Square constantly asks for how much tip you want to leave when paying for tastings and bottles. Quite a boon for these folks!

Pete
Long SQ

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…because I believe Square’s growth is accelerating. And I think that’s an important concept to
grasp with MB&H.

If growth actually steadies this quarter, I imagine you’ll be back to your dilemma about whether or
not to trim. If you trim, then you’re probably going to look for something to replace it that is not
only growing fast but is “cheaper” or accelerating.

This reminds me of being in line at the grocery store. I see the line next to me is moving faster so
I jump over to that line just as the man at the head of that line starts arguing with the clerk. So
I rush over to aisle six which is moving gangbusters just when the lady in the front of that line
drops her purse. Maybe I should’ve just stayed in the line I was in.

One way to get at this is to look at salesforce.com (CRM). CRM is the Poster Child for these SaaS
moonshots. In the first four years after its IPO in 2004 there were quarters when growth decelerated
and there were times when P/S was in the high teens. But even if you bought at the very worst time
in those first four years, you’re return today – if you stayed in line – is still an annualized
21%. At other times it’s closer to an annualized 30%.

The key to buy and hold – investing, really – is compounding, not growth.

Ears

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Growth rate: The key to modified buy and hold

Obviously, Saul’s strategy works. My biggest gripe is with the label “Modified Buy and Hold.” For me, that’s just trying to leverage the connotations of the accepted wisdom of “Long Term Buy and Hold.” As darrellquock points out, Saul’s portfolio turn-over is quite large within relatively short periods of time.

Essentially, MB&H chases long term growth, has no patience for hiccups in growth (look at SKX, for instance), and is a concentrated portfolio to enable close and almost daily re-analysis. This isn’t a simple thing to do. When Saul posts his moves, I’m sometimes surprised at his thinking, saying to myself “Why is he getting out of that great stock now?” Earslookin cashier line analogy is appropriate, as is my own “which lane should I be driving in”? I’m looking for the best lane to be in, and my intent is to stay in the lane for the whole trip. However, more often than not the best lane changes. I round a bend and see a truck in the left lane, or I see a tailgater and so move a couple lanes away for safety. On roads I travel often I know the traffic patterns and will stay in a slower moving lane because I know it’ll open up soon and I’ll be ahead or at least as fast as if I changed lanes and then tried to merge back into it when it opens up. But, I don’t chase a 1 or 2 car short-term advantage - I’m looking down the road as far as I can.

Anyway, I don’t see “buy and hold” fitting Saul’s modus operandi and wish we had a better name for it. Yes, Saul invests not for short-term gains, but more often than not, the companies in which he invests don’t meet his expectations over the long haul. Heck, he’s out of Amazon now; He has his reasons, and they’re certainly as good as any, if not better than most.

It would be interesting to see what the average length of time Saul holds a stock for is, and what the standard deviation from that is as well. Anyone statistically minded out here?

And just to be super-clear: there is no problem, no shame, no criticizing of Saul’s strategy not being a modification of a long-term buy and hold. His strategy is based on what the current long term view is. It’s just that that view changes pretty darn frequently if you’re thinking along the lines of buying and holding a stock for 5-10 years.

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Anyway, I don’t see “buy and hold” fitting Saul’s modus operandi and wish we had a better name for it.

Smorg,

I think that’s fair. But here are a couple reasons I think the term is helpful:

With traditional B&H, what’s the real difference other than longer holding periods? I mean, you still ought to keep an eye on the changing environments companies do business in. Even if someone gives companies a longer leash than Saul, I don’t think you would expect them to hold literally forever. Even the Fool recommends selling occasionally. If you’re basically checking out mentally, not paying attention to how a company is changing (growth, customers, competition) or the alternative investments that are out there, it seems to me you’re leaving a lot of opportunity on the table. A little modification seems in order.

The key to buy and hold is to own really good companies. The only tweak MB&H really makes is to try to own them at the right time (when the growth and valuation make sense, and better alternatives can’t be found). The similarity? Good companies. I think that’s a key commonality – sort of what the “B&H” part means to me. In other words, including “B&H” in whatever you call Saul’s approach is a way to distinguish that it’s based on actual fundamental analysis…rather than voodoo (technical investing, momentum investing, etc). We’re not looking at charts or finding the hot stock without understanding the underlying business. That’s anti-B&H.

That said, the term isn’t the important thing to me. It’s understanding why it works. I think these are two reasons it even works better than traditional buy and hold.

Bear

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.rather than voodoo (technical investing, momentum investing, etc

Fwiw, Momentum investing, like value investing, is proven to beat the market over the long-term. Humans under-react to good news and to bad news, buying too slow when the story is great [look at Amazon, PCLN, Monster, AZO, Apple, even Shopify] and selling too slowly when it turns bad, or bad to worse [JCP, SHLD, name your retailer, B/C-class malls, IBM, any of the e-commerce blowups, mortgage insurers, E+P bubble, et al]

There’s almost an infinite number of papers showing this at AQR and hundreds of other places. I’ve posted several of the white papers at TMF a few times, but AQR probably has one of the best repositories.

Of course the best stocks are the ones that combine value and momentum!

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If you’re basically checking out mentally, not paying attention to how a company is changing (growth, customers, competition) or the alternative investments that are out there, it seems to me you’re leaving a lot of opportunity on the table.

Back to the driving analogy, LTBH is like getting in the left lane and just staying there. MB&H is constantly looking ahead to see what the best lane to be in is. You can get to your destination sooner with MB&H, but it took more work. With LTBH, there’s less effort. What we all agree on is that constantly changing lanes to get ahead of a car or two isn’t worthwhile.

That said, the term isn’t the important thing to me.

But, the label can be confusing to new-comers. Maybe I’m slower than most, but it took me a bit to sort out what seemed like constant getting out of companies (even before they qualified for LT Cap Gains), and then going whole hog into newly discovered companies with the MB&H label.

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"Sometimes it’s good to be flexible and not be so stubborn when things change.

Change is difficult and admitting you were wrong is extremely hard.

2 years ago, Saul’s top 4 stocks, which nearly made up 50% of his portfolio were CELG, SKX, SWKS, and BOFI.

If Saul just stood pat and “bought and held”, ignored all of the changes, his portfolio results would be no where close to what it is now…"

in retrospect when you look at those stocks, you say that was a mistake because it has not risen or not much in the past year or 2 ago.

But what made him switch? he got into a rising tide and started to pitch into it so much so that after 2 years his portfolio is completely different.

The admission of mistakes is a good thing to have but how do you define mistake in stock picking? surely in the past year or two it hasn’t gone well for these stocks. But the potential you saw 2 years ago, is it still there? and could those still be orders of magnitude higher after a few years? You can define ‘mistake’ by a time period of 1 year or 2. You can also define in terms of months or weeks or days. What is the timeframe when it becomes just luck or statistics?

how do you dip in a growing trend?

tj

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You can define ‘mistake’ by a time period of 1 year or 2. You can also define in terms of months or weeks or days. What is the timeframe when it becomes just luck or statistics?

An important point. My answer?

When the stock goes down and then company results follow suit, the market was right.

When the stock goes down and the company keeps performing well, the stock goes back up, proving the market was wrong.

What do you think about that?

Bear

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Smorgasbord1:

your analogy of choosing the traffic lane has come up in my mind many times. On the end you don’t arrive at your final destination much quicker (or even slower) than if you stayed in your lane.

I don’t believe in intuition in stock picking (it simply does not exist in this endeavor). I don’t know if anyone can explain how one would switch from this to that. What is the process and rational to do so? I can see that by doing that frequently (like weaving in and out of lanes) maybe you can get ahead faster in the short run but doing that in the longer run? doesn’t that invite accidents?

I don’t think that good results from some proves anything. More power to the ones that do that and gets ahead but I think most investors will not and could not do that. Not because of lack of skills or dedication but simply because most will not get out sized gains relative to the market. That is just by definition and statistics.
In order to make outsize gains, you need to invest in an extraordinary business that remains strong throughout an era i.e. a long time. It is impossible to really know the full potential of any business really. You can only hope it will become such a thing.

The weaving in and out of lanes may work for some and be rather exciting for others but that’s not for me.

tj

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The weaving in and out of lanes may work for some and be rather exciting for others but that’s not for me.

that’s the difference between you and Saul.

If we use you as an example, you stated in an earlier post regarding Chipotle :

Despite setbacks, Chipotle is still a good long term play especially from here. In the shorter term, no one could know where it is headed. Some did hope that it would turn around faster but it did not. It will turn around nonetheless.

tj

I can’t speak directly for Saul, but I think he would have gotten out of CMG when the story changed and put his money in better opportunities instead of waiting for a turnaround that you are doing…

You are basing your investing philosophy on “hope”. Hope and investing should never go in the same sentence together…

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