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Dividend Investor
Safe Income and Dividend Growth

Hold vs. Buy Ratings

I want to clarify a few things about our Hold and Buy ratings.

Several members have contacted me recently to ask about the timing of my Hold and Buy recommendations. Specifically, these long-term investors want to know why I sometimes put good stocks on Hold at low prices and then switch them to Buy once they start going up. Isn’t that the opposite of “Buy Low, Sell High?”

In light of these questions, I want to clarify a few things about our Hold and Buy ratings. First, unless otherwise stated in the recommendation, a Hold means just what it says: Hold the stock. It doesn’t mean the stock is in danger of being sold unless we explicitly say so. Usually it simply means that we think the stock is still a good one to have in your portfolio, but that we don’t think it’s at a good buy point. It may be overextended, or in a downtrend, or other risk factors may be at play.

It’s the second situation—putting a stock on Hold because it’s going down—that sometimes brings out the letters from value investors. If it’s still a good stock to own, shouldn’t it be an even stronger Buy when it’s cheaper?

In one sense, yes, and we’ll get to that. However, when a stock is declining (more than usual, I don’t put a stock on Hold simply because of normal volatility); the fact is that it’s more likely than usual to keep declining. And I’ve learned that investors don’t like it when something goes down right after they buy it—understandably.

For example, I put GM on Hold on January 6, at about 31, when it was about 14% off its December highs. The stock was still a good value, but the action of the market and the stock were both telegraphing high risk in the short term. Sure enough, GM declined another 17% between January 6 and the low on February 11, falling below 27. So investors who bought on January 6 would have been pretty disappointed.

I put the stock back on Buy on March 9, once the buyers again took the upper hand.

Would it have been smarter to keep the stock on Buy throughout the correction, giving some investors the opportunity to buy the stock at the low of 27? Possibly, but you know what they say about buying at the bottom and selling at the top: only liars do it consistently. Far more likely is that buyers who bought on January 6, and immediately lost 17%, would become discouraged and sell near the bottom.

I’ll also sometimes switch recommendations to Hold when short-term risk rises for another reason, like a market downturn or Fed activity, for the same reason.

As the value investors who write in correctly point out, these rating changes don’t really impact the picture for long-term investors. So if you really don’t care what the stock does in the short-term, you can still buy some of the positions that are put on Hold for one of these reasons. But be careful! Some Hold ratings do mean that the longer-term picture is becoming muddled as well. I always make this distinction clear by explaining the reason for a change to the Hold rating in the write-up.

Lastly, another question I get fairly often concerns Buy ratings: should you still buy a stock several months after it’s been added to our portfolio? The answer is simple: if it’s still rated Buy, go ahead. Take Reynolds American (RAI), for example. We added the stock to our portfolio on July 2, 2014. A year later, the stock had risen 24%, but we still had it rated Buy. If you ignored the stock then because it looked like the big move had already happened, you’ve missed out on an additional 35% gain since then. This is even truer on longer time scales.

It’s hard but important to suppress the human instinct that says it’s “too late” to buy a stock that’s already had a good run. Yet trends tend to last longer and go further than anyone expects, so buying a stock that’s going up is exactly what you should be doing.

That said, buying on pullbacks (using buy orders or options, or simply by watching) is a great way to get into an uptrending stock at a better price, and can usually be accomplished without too much difficulty in a market as volatile as this one.

As with Hold ratings, I will often say something in the commentary about a Buy-rated stock that’s important, like suggesting you wait for a pullback in a stock that’s looking overheated short-term. Both of our utility stocks, Xcel Energy (XEL) and Consolidated Edison (ED) are good examples of this today. And Reynolds American (RAI) provides an example of the next step—I’ve been telling investors to try to buy on pullbacks for a while, and the stock is now offering a nice one (but is still healthy long term). So don’t go out and load up on everything rated Buy, or dump everything rated Hold: read the advice, and treat each investment individually.