What is a Terminal Value?
If you’ve ever asked yourself “what is terminal value?”, you’ve come to the right place. Understand its definition, scope, and the forms it takes.
27 Jun, 2021
8 min read
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Broadly, there are two types of participants in the stock market – long-term investors and traders.
Overview
Whereas traders buy and sell stocks and other securities frequently based on the conditions of the market, the performance of companies and macroeconomic factors, investors are focused on building their wealth in the long term.
Some of the most successful investors in the world, including the likes of Warren Buffett, have used a combination of long-term and value investing to create incredible wealth. From among the ranks of those emulating such legendary investors, the buy-and-never-sell type of investor has emerged. Such an individual often believes in passive investment, along with value trading and money invested over long periods of time.
Perhaps what primarily defines such an investor is their anticipation that the market could crash at any time. What aids this line of thought is the possibility of earning large compound interests on their initial investment, especially with a hands-off approach. However, this approach towards investment is not as simple as it sounds.
The buy-and-hold strategy
Buy and hold is a strategy used by a large number of investors to purchase stocks or other assets and hold on to them over a long period of time. The ups and downs of the market are of little consequence under this strategy, and such investors are unflinching in the face of changes in technical indicators.
The buy-and-hold strategy works best when investments are made in equities rather than other assets such as bonds. Moreover, while there are merits to both active trading and buy-and-hold, the latter enjoys more tax benefits since such investors can choose to defer taxes on long-term capital gains.
Another defining characteristic of buy-and-hold investment is that investors do not view trades as simply a way to make a quick buck, but are deeply concerned with the actual machinations of the companies' operations. Since shareholders are entitled to ownership and voting rights in a company, they can have a direct say in matters such as the appointment of directors, mergers and acquisitions, and investors' rights.
The long-term investor vs the short-term trader
Investors often tend to favour active investing over passive, or vice versa, and both sides make some good points. Active investments require the trader to hire a portfolio manager or act like one themselves. It is often a full-time job and warrants expertise and in-depth analysis to participate in or withdraw from investments. A professional portfolio manager will usually be in charge of a team of analysts who study all factors - qualitative and quantitative - before deciding where and how to allocate an investor's capital.
Active investing can be highly flexible, allowing investors to buy stocks that may perform well in the future. It also enables managers to participate in hedging through put options and short sales. The investor has better control over his finances and can choose to abandon securities that are losing money, or buy the ones they feel will lead to maximise gains.
Passive investors, or those who are in it for the long haul, often follow the buy-and-hold strategy. This type of investing is usually very low-cost and can be carried out by purchasing ETFs or mutual funds. The investor is often required to lock in the amount of investment for a period, which means that they do not have the option to buy or sell depending on short-term market conditions. Those who are not confident about actively trading on the stock market, or lack the essential know-how but wish to make gains over the long term often become the buy-and-never-sell type of investors.
Why the buy-and-never-sell investor is conflicted
When hard-earned money or savings are on the line, it can be very difficult for the most patient investor to tide over adverse market conditions unflinchingly. This means that even the buy-and-never-sell type of investor has to sell their stock sometimes. Here’s why.
Not all buy-and-hold investors invest passively. Some may understand the market very well, and yet choose to follow the buy-and-never sell strategy. However, with such knowledge comes the burden of becoming easily conflicted. Such investors usually operate with the assumption that the market could crash anytime, therefore, holding on to their investments. However, a sustained increase in stock prices could cause them to abandon their investment philosophy in the pursuit of more opportunities.
Even though the idea behind buying and holding is to just stay put, it can cause ample anxiety among investors. This happens despite the fact that the simple act of doing nothing emanates from a well-calculated strategy that may have involved multitudes of smaller, albeit important, decisions. The key to being an investor who buys and never sells, therefore, is patience. And, chances are, it will go rewarded.
When markets are volatile, investors may feel that their hand is forced to do something, but long-term investors should heed the advice to not touch their investments. Selling during turmoil will keep investors from achieving their ultimate goal – long-term benefits. Experts have warned that investors should avoid panic selling because the worst days on the market are usually followed by the best days.
Why sell?
While there are good reasons for long-term investors to hold on and aim for delayed benefits, they should be able to sell their assets if they have a compelling reason. If investors realise that the investment was made based on inaccurate facts, the stock has become overpriced, or if they are simply in need of cash, they should sell their stocks, even if it goes against their investing logic.
If they realise that the company's business model will not work in the longer run, they should perhaps consider selling its stocks. In fact, it may be a good idea to divert that investment to some other stock, rearranging or diversifying the portfolio. Such an adjustment to the investor’s portfolio could also be warranted because of a significant life event such as childbirth, divorce or retirement.
Another good reason to sell would be if they needed the money invested as capital for something. This would be a better option than availing a loan and paying off the debt over many years. Finally, if there has been a development concerning the company the investor has invested in, or other news that may be detrimental to their prospects, they should consider selling.
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