Monday, January 17, 2011

The Importance of Buy & Hold

In mid-March 2008, when the market was down 25.85%, I was quietly confident that there shouldn’t be a huge amount of downside left after such a substantial decline.

Now, you will note from the above statement, I don’t rate much in the forecasting stakes – the market went on to fall roughly as far again over the ensuing 12 months.  What I can lay claim to is some solid results in the stock-selection stakes.  I found Credit Corp Group (ticker - CCP), they seemed to tick a lot of the boxes I seek, reasonably long and consistently profitable trading history, high return on equity, averaging over 25%.  Their only issue would seem to have been that they were far too heavily leveraged at a time when such leverage was frowned upon due to seizing credit markets.  A quick perusal of their business and their cash flows, however, indicated that if they committed seriously to paying down their debts, they could do so in pretty short order – they did and they have (cut by roughly 2/3 in the next 2 years).

So I bought a small parcel of CCP @ 66 cents 14/03/2008 (it is not a big holding, today they make up less than 4% of the family portfolio).  In pretty short order, they hit 99 cents (up 50% on purchase price), and then they bottomed at 39 cents on 28th January 2009 (down 40.91% on my purchase price).  All this indicates is that it was a volatile period; those of you in the market then will already know this.
In any case – as at the time of first drafting this post (20/12/10), CCP is priced at $4.05 and they have returned me 14 cents in dividends since purchase.  So they represent $4.19 of value to me today, which equates to an annualised return of 95.83%.  I don’t point this out to gloat; I have made a couple of purchases that worked out better & a great many that did not nearly so well (doing not nearly so well as 95.83% can actually be quite satisfactory).

In truth, the point I want to make regards the ‘buy & hold’ ethos.  I make the point as follows – In order to maintain my annualised growth of 95.83% on my original 66-cent purchase price, CCP will need to grow my investment by 63.25 cents per year (.9583 x 0.66).  This means that to get to 20/12/2011 still carrying my return of 95.83% pa (on original purchase price), I need CCP to finish the year at about $4.68 (including dividends).  Now this only represents a return of 15.62% from their current position. This is only a little more than 3% above the historic market (S&P/ASX200 TR) return, and entirely possible from this company.

Year
Price
Growth
20/12/10
 $    4.05

20/12/11
 $    4.68
15.62%
20/12/12
 $    5.31
13.51%
20/12/13
 $    5.95
11.90%
20/12/14
 $    6.58
10.63%
20/12/15
 $    7.21
9.61%
20/12/16
 $    7.84
8.77%
20/12/17
 $    8.48
8.06%
20/12/18
 $    9.11
7.46%
20/12/19
 $    9.74
6.94%
20/12/20
 $   10.37
6.49%

The table set out to the left further demonstrates this proposition stretched out for the next 10 years.  You will see that by the 10th year, the required return (assuming a smooth return of 95.83% per annum on my original investment) is only 6.49%.  I can go out today and get a 6.5% return from any number of places, so that will be eminently achievable.
Though I haven’t included the next 10 years of the table, I can assure you it gets more impressive, by the 20th year all I need in order to continue to grow my starting capital by 95.83% annually on its original value is to grow my holding by only 3.94%.  Clearly, if 3.94% is all the return I expect, I may start to move some of this capital elsewhere, but you see the power of the notion.  This is a demonstration of one of the most powerful parts of share investing, the power of the ‘free leverage’ afforded by uncrystallised capital gains. Tony Hansen - 17/01/2011.

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