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Consequences of holding a stock for too long

 

Tuesday, November 17th, 2015

I've often warned investors about buying and selling based on emotion. However every once in a while I hear about someone that held a stock for 40 or 50 years and how great they did, just like the trader’s success story you hear every so often about how great they did trading all the time.

Investors must also be wary of holding companies for too long and holding them blindly. By holding a company too long, a poor performance can be masked by a good long-term performance.

Let me give you an example- 30 years ago Exxon Mobil traded around $12 per-share and the stock is currently around $80 per share. Over 30 years your investment is up 6.6 times, which sounds very impressive.

Another big factor is that over 30 years, Exxon Mobil has continued to pay a dividend and based on current prices, has yielded about 3%. So one may think they have a great return, doing the calculation of the internal rate of return, 30 year investment return for Exxon Mobil was 6.6%.

The sad news is at the same time, The Dow Jones industrial average returned 9.0%. Had Exxon Mobil performed at the same rate as the Dow Jones industrial average, the stock price would be nearly double what it is today at $159 per share.

So what happened to the great return?  The current stock price is roughly the same price it was nine years ago, so with the exception of the dividends investors have made no money on their investment if they bought nine years ago today.

The reason for this is that nine years ago, the stock had high valuations and should have been sold. It could have been bought two or three years later at around $60 a share, which would have done two things: locked in a larger profit back in 2006, and also given investors a very nice return from 2008 to even current levels.

Some investors may argue that they paid no taxes and it was worth getting the lower return. Two things to point out here are that an investor is only taxed on their gain, while investment loss is based on the entire value of the investment.

Let's say that an investor invested $50,000 in a stock, and it appreciated 100% to $100,000. If the investor took advantage of long-term capital gains tax on his investment, which in the state of California which is the highest in the country, the overall tax would be about 25% or $12,500.

If the stock were to decline more than 12.5%, the investor would be ahead of the game by selling the stock and paying the tax. And if the investor was smart and could find another undervalued company, their portfolio return would be enhanced greatly by selling high and buying low. This would be as opposed to holding onto the stock when it is highly priced, watching it drop in price and waiting for years just to break even.

Another thing investors have to be worried about is what if the company that you've held for 10-15 years goes bankrupt? It does happen and when this happens the shareholders are left with nothing after the assets have been sold, creditors paid, and the government collects their taxes.

Here are some companies that have gone bankrupt that may surprise you:

 In the 80s you may remember a big oil company called Texaco. They ended up owing $10.5 billion and had to file bankruptcy. They were later bought by Chevron for the assets and shareholders received nothing.

Delta Airlines looks pretty good right now, but it hasn't always been that way. In September 2005 high fuel prices and increased competition from low-cost carriers caused them to file bankruptcy. Prior to that in 2002, United Airlines (which was hurt by 911) lost $3.2 billion and filed bankruptcy.

General Motors wasn't the only car company to file for bankruptcy and cause their shareholders to lose all their money. A company that has been around for nearly 100 years, Chrysler, filed bankruptcy in April 2009.

I'm sure you remember back in 2001 the story of the big utility company called Enron, which was a Wall Street darling but ended up being a corrupt company and had to write down $1.2 billion in assets. It forced the company into bankruptcy and now both the CEO and the CFO spend their days in jail.

No industry is exempt from filing bankruptcy. You may remember the large bank Washington Mutual, which was forced into bankruptcy because of bad investments and subprime mortgages. The Federal Deposit Insurance Corporation seized the assets and sold them to J.P. Morgan Chase. Shareholders once again received nothing from the sale of the assets.

When a company files bankruptcy, their debt exceeds their assets and all debts and liabilities (including taxes and employee payrolls) must be paid before the stockholders receive a dime.

So whether you are an active stock trader or think it's a good idea to buy and hold a company forever, the only true way to make money investing for the long-term is to spend the time doing the research, understanding the business, and making sure as an investor you are not blindly holding a company and thinking your return is pretty dead.

Do you have a question or a company you would like us to take a look at?
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