One obvious danger with that notion is that it has taken on investment's equivalent of holy writ because it's so closely linked to Warren Buffett, the most successful and famous investor on the planet. If the Sage of Omaha says it, it must be true. Yet any piece of conventional wisdom is worth questioning. And this piece, that an investor - a passive investor like you or me - should never sell shares in a brilliant company, looks worryingly dogmatic.
First, let's get the pedantry out of the way. At some point every holding in a portfolio has to be sold - death or the avoidance of penury will see to that. In that sense, 'forever' never applies. Second, is it fair to attach the holding-forever notion to Mr Buffett? Probably. I could not find a witty little Buffettism that was relevant. However, in the 1987 annual letter to shareholders from Berkshire Hathaway (Mr Buffett's holding company), he said: "We need to emphasise that we do not sell holdings just because they have appreciated or because we have held them for a long time. We are quite content to hold a security indefinitely so long as the prospective return on capital of the underlying business is satisfactory."
I could counter with a witty investment aphorism from Peter Lynch, who ran the Fidelity Magellan fund during its wildly successful 1980s: "Never fall in love with a stock," he cautioned, "because, as sure as hell, it won't fall in love with you."
And that's a danger. If we own shares in an outstanding company and the performance of our holding is equally good, we want that to continue - both for the company to continue posting top-quality results and for the share price to motor upwards. When one or both falter, we search for plausible explanations as to why the setback will be temporary. Chances are, however, that we are being driven by our emotions and we have left rationality behind. If we can't find plausible explanations, then implausible ones will do just as well; except that in the long run they will cost us money.
Besides, Mr Buffett acknowledges that there is a time when it is right to sell a holding. He also said in the shareholders' letter just quoted: "Sometimes the market may judge a business to be more valuable than the underlying factors would indicate it is. In such a case, we will sell our holdings."
Mr Buffett's words simply accept that a company's share price will be more volatile than a measure of its value - its profits, earnings per share or that mysterious phenomena, its 'intrinsic value'. From that proposition follows the notion that a company's share price can become either ridiculously overpriced or stupidly underpriced - although it's horribly difficult to spot the ridiculousness or the stupidity at the time.
To illustrate, consider this contrast using data from Castings. In the past 20 years, the company's operating profits have risen by 11.5 per cent a year on average with a standard deviation (a measure of variance around the average) of 26 per cent. Over the same period the average rise of its end-March share price is 10 per cent, but with a standard deviation of 36 per cent. In other words, over the long haul Castings' share price has pretty well reflected the growth in company profits, as you would hope in a fairly efficient market. But it has done so in such a higgledy-piggledy way as to make the share price vastly overvalued or undervalued at various times.
That is one reason why it can be right to sell shares in a great company. Another is that it is often difficult to know whether or not a company is outstanding. Mr Buffett once said: "The definition of a great company is one that will be great for 25 to 30 years." Well, yes, except that it's fair to ask: is he referring to the past or the future 30 years? That's not being flippant. The mutability of the business world is too rapid to be able to project five years into the future, let alone 25 to 30. There is no telling that a great company will remain great.
That's partly why the major argument in favour of never selling shares in outstanding companies has less to do with the companies and more to do with investors' difficulty in buying and selling at the right times. In which case, a buy-and-hold plan is much better. Or, as Mr Buffett said in his latest shareholders' letter: "Since the basic game is so favourable, it's a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of 'experts' or the ebb and flow of business activity. The risks of being out of the game are huge compared with the risks of being in it."
