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Why We Prefer To Take A Long-Term View

Benjamin Graham, the mentor to Warren Buffett, once said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine”. In other words, in the short run, there is a lot of market noise and investor emotion that can drive stock prices. But, over time, stock prices typically reflect the fundamentals of the underlying business.

Whilst stock prices can swing like a pendulum, reflecting periods of unbridled optimism as well as undue pessimism, there is a case to be made for taking a longer term view when holding stocks, particularly for high quality businesses.

On a recent trip to the US, what stood out was the overwhelming short termism of many of the other investors I spoke to. At company meetings I attended, questions were pointed at the next quarter and whether the company was likely to beat or miss their earnings guidance. Many of the investors thought about stocks, and invested, with much more of a trading mentality.

While trading is a perfectly fine way to make money, and some traders are fantastic at it, it is not something we profess to know a great deal about. Rather, we stick to our process which is picking under-priced businesses that we feel have a high probability of appreciating in value over time.

You might ask why have we chosen this approach of holding stocks for the longer term. The Montgomery Global team has a proclivity to hold undervalued stocks where time is needed for either: (i) the stock price to converge with our estimate of that company’s intrinsic value; (ii) the business value to grow; or both (i) and (ii).

Whilst we welcome short term market noise, given the mispricings and opportunities it often throws our way, a longer term holding period is usually required for our investment theses to play out. You typically need time for these value gaps to close, whether that be due to positive business developments, or broader recognition by the market of the stock being undervalued.

The greatest area where a long time horizon serves as an advantage is for so-called “compounders” – that is, companies that are able to employ capital at very high rates of return and thus compound the value of the business over time. Time is the friend of these businesses, and significantly wealth can be generated by identifying these businesses, buying them cheaply, and holding them for a long time.

Another advantage of a longer investing time frame is the avoidance of excessive transaction fees, such as commissions and taxes, that occur through frequent trading.

Furthermore, a less recognised benefit is the compounding of the deferred tax gain component. You see, when you hold a stock that appreciates in value, you only have to pay tax if you sell your investment. For stocks that appreciate over long periods, investors benefit from compounding the deferred tax gain, or the portion of their investment gain that would need to be paid out as capital gains tax if they sold. As soon as you waver and sell out, then you create a tax event and reset the deferred tax compounding clock.

Whilst there is more than one way to make money in the stock market, investors need to ultimately identify an investing style that matches their own temperament and needs.

Are you looking for a simple way to invest in high quality global businesses? Find out about the new Montgomery Global Equities Fund – a global fund targeting growth and yield. Listing soon. Find out more here.

View More Articles By The Montgomery Team

Roger Montgomery is the Chief Investment Officer of Montgomery Investment Management, montinvest.com, and author of blog.rogermontgomery.com.

Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.



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