The buy-and-hold approach has come under fire in recent decades, but I still own and recommend what I call buy-and-hold stocks. These are stocks that I've owned for years, and I think they're a key reason I've been able to outperform the market over time.
There's no foolproof formula for spotting them; otherwise, everyone would own them, and potential gains would shrink dramatically. (I'm far from infallible, having bought stocks that seemed to meet my criteria only to end up selling at a loss.) No matter what happens in the short term, I don't even think about selling a member of this group unless my thesis for buying in the first place has proven wrong.
What does it take to gain admission to the buy-and-hold club?
* To me, the most important quality for a stock is that it have market power -- legally, of course. Natural monopolies, as they're often called, derive from proprietary technology others cannot duplicate; large economies of scale; or best of all, a combination of both. There's a sure clue to such companies embedded in their financial statements: a high profit margin.
* Even a market dominator needs growth to fuel a significant rally in its stock price. Growth can come from long-term trends that boost revenue and profits, or by taking share from what (few) competitors already exist, or from some aggregate of the two.
* Stock prices rise when results defy expectations, so the greater the skepticism about a successful company, the greater its potential -- as long as the skepticism turns out to be unjustified. Skepticism is often reflected in a low price/earnings ratio relative to a company's growth prospects, which results in a low price/earnings-to-growth ratio (or PEG).
Here's how the criteria are reflected in five companies whose stocks I plan to hold through thick and thin.
I bought shares in Google's initial public offering in 2004. It has long been my conviction that Google's algorithms, the product of innumerable search requests, confer a natural monopoly on its search engine, which is constantly being refined and updated. After almost seven years as a public company, Google was still able to report earnings and revenue growth over 20 percent in 2010. More broadly, if Google's revenue is viewed as part of the global advertising market, it still holds a very small share. The potential of digital advertising strikes me as huge, and Google begins with a big advantage. Nonetheless, Google's forward P/E is close to the market average; some managers are even calling it a value stock.
BHP Billiton (BHP)
The Australian mining giant is the world's largest natural resources company, with important positions in holdings in at least a half-dozen important metals and minerals. Economies of scale in the mining business are so great that the likelihood of significant new competition is slim. Why doesn't everyone own this stock? Apparently, many investors still think of commodities as highly cyclical, low-margin businesses. Some investment firms have recently downgraded the stock.
LVMH Group (LVMUY.PK)
Paris-based LVMH is a luxury conglomerate and an exception to my rule of thumb that fashion rarely lends itself to long-term dominance. Brands like Dom P rignon, Fendi and Louis Vuitton transcend fashion in the hands of LVMH's managers, who seem to have an uncanny knack for marketing. Brands can themselves confer pricing power. (Louis Vuitton wasn't discounting during the recession.) LVMH Chief Executive Bernard Arnault has pursued growth in part by snapping up other iconic luxury brands. In March he announced that LVMH was buying jeweler Bulgari, and he's been stalking one of the most successful brands in the world: Herm s.
Oracle has carved up much of the worldwide enterprise-software market with rival SAP of Germany, with which it competes fiercely. When the Justice Department sued in 2004 to block Oracle's acquisition of PeopleSoft, on grounds that the merger would confer too much power on Oracle, CEO Larry Ellison stared down the federal government -- and won. Whether or not this was good for consumers can be debated, but it was undeniably good for Oracle shareholders. Ellison has also pursued growth, most recently by buying Sun Microsystems, a hardware maker whose products compete with giants like Hewlett-Packard. I predict this kind of vertical integration won't be as easy as acquiring other software firms, but it's undeniably ambitious. And so far it seems to be working.
Norfolk Southern (NSC)
An old-fashioned railroad may seem stodgy in this group, but think about it: Who's building any new ones? Railroads enjoy large economies of scale and offer cheaper alternatives to truck and air delivery, particularly in the heavily congested eastern half of the U.S., where Norfolk Southern operates. Its results are sensitive to the economic cycle, especially demand for the raw materials it hauls so cost-effectively. But we're still in the early stages of what could be a long-term recovery, from which Norfolk Southern should benefit. I wouldn't expect a railroad to end up on any top 10 performing stocks of the year lists, but when it comes to the long term, slow and steady growth is fine with me.