What is the benefit of holding stock for the long term?

Long-term investing in stocks is one of the most effective strategy for building wealth over time. Long-term investing in stocks allows investors to capitalize on the growth of fundamentally strong businesses. Over time, companies reinvest their profits to grow their revenue and improve their margins. This continual activity time after time yields exponential growth for quality companies. But companies needs time to show exponential growth. When companies fundamental grow exponentially, their stock also becomes a multi-bagger (see list of Indian stocks suitable for long-term holdings).TopicsIntroductionBy focusing on strong companies and holding them for a decade or more, investors can ride out short-term market volatility. For a beginner, it is necessary to first learn how to manage market volatility then think about returns. Long-term holding is the easiest way to manage volatility.As a by-product of long-term holding, which we must do to manage volatility, we will experience another benefit. What is it? The share price growth emanating out as a result of growth of the underlying businesses.It is also important to note that long-term investing is not a blanket strategy that works for every stock.The basic requirement is, the fundamentals of the business must be strong. When we say fundamentals, it includes quality of management, profitability, financial health, competitive advantage, and future growth prospects. A suitable mix of these factors drives growth in a company.These factors tell us whether a stock is worth holding for periods like 10 years or more. Holding stocks for long-term whose fundamentals are weak can only lead to losses.So beginners, who want to practice long term investing, they must first learn to decipher between fundamentally strong and weak stocks. My Stock Engine’s Overall Score is one metric that scores companies based on the metrics like profitability, growth, etc.Q1: What are the best stocks to buy for the long-term in India?AUTO OEMAshok LeylandEscorts KubotaMaruti SuzukiTVS MotorsHero MotoCorpBajaj AutoEicher MotorsMinda CorpSteel Strip WheelsUNO MindaSansera EngineeringCIE AutomotiveBANKSHDFC BankICICI BankKotak Mahindra BankSBIBank of BarodaFederal BankKarnataka BankIDFC First BankCity Union BankBandhan BankDCB BankNBFCBajaj FinanceCanFin HomesAptus Value HousingChola InvestManappuram FinanceMAS FinancialCreditAccess GrameenSFBAU Small Fin BankEquitas Small Fin BankUjjivan Small Fin BankFMCG / CDAsian PaintsBritannia IndColgateCCL ProductsDabur IndiaHULITCJyothy LabsNestleVBLABFRLAvenue SupermartsBata IndiaWestlife DevelopmentPage Ind.Relaxo FootwearTRENTVMARTEthosSpeciality ChemicalsAarti IndApcotec IndArchean ChemCamlin FineVanin FlourineNOCILAgri ChemicalPI IndDhanuka AgriMid-CapsMold-Tek PackingPraj IndKirloskar BrosPitti EnggVA Tech WabagGravita IndiaCementDalmia BharatJ K CementsJK Lakshmi CementBirla CorpHeidelberg CementStar CementACCShree CementAmbuja CementOrient CementUltratech CementRoad InfraKNR ConstructionPNC InfraH.G. InfraG R InfraprojectsJ Kumar InfraprojectsDiversified FinancialsNippon LIfeSBI CardsSBI Life InsuranceOther Investment CompaniesAstralEmbassy REITIndian HotelsChalet HotelsPharmaAbbot IndiaAarti DrugsAurobindo PharmaBioconDR ReddyLupinGland PharmaCIPLAPharmaAbbot IndiaAarti DrugsAurobindo PharmaBioconDR ReddyLupinGland PharmaCIPLAMetals & MiningHindalcoNalcoSAILTata SteelAPL Apollo TubesJTL IndCoal IndiaITTCSInfosysHCL TechWiproTech MahindraLTIMindtreeKPIT TechPersistentCoforgeZomatoMetals & MiningHindalcoNalcoSAILTata SteelAPL Apollo TubesJTL IndCoal IndiaInfra-OthersKEC Int.RITESPSP ProjectsAhluwalia ContractsHealthcareHCGKIMSGlobal Health.Real EstateMan InfraPrestige EstateArvind SmartspacesQ2: What is the benefit of holding stock for the long term?Holding stocks for the long term offers several advantages, particularly when viewed over a horizon of 10 years or more. Here are the key benefits:2.1. Compounding Effect: The biggest advantage of long-term stock holding is the power of compounding. When dividends and earnings are reinvested, they generate returns on the initial investment, which in turn generate more returns. Over time, this cycle leads to exponential growth. Stocks such as those in the BFSI sector, where banks have shown steady growth (e.g., HDFC Bank’s net profit in Q2FY25 rose 3.4% YoY ), often deliver compounding benefits through stable dividends and price appreciation.2.2. Lower Market Volatility Impact: In the short term, stock markets can be highly volatile. However, over longer periods (like 10-years), these fluctuations tend to smooth out. Sectors such as IT, despite occasional slowdowns due to global factors (like U.S. elections, etc ), have consistently performed well over longer periods due to global demand for technology.2.3. Capital Growth: Holding a stock long-term allows investors to benefit from the growth of the underlying business. For instance, sectors like Telecom and Automobiles have shown growth trends based on increasing demand and evolving business models. Bajaj Auto, with a projected 23.7% YoY revenue increase , is an example of a company growing in value over time.2.4. Dividend Income: Long-term investors benefit from regular dividend payments. Dividend-paying companies tend to have stable cash flows and profitability. Over time, these dividends can be reinvested, adding to the compounding effect. For instance, stocks in the Consumer Staples sector, such as Hindustan Unilever, provide steady dividends . A long-term investor not only benefits from price appreciation but also from cumulative dividend income.2.5. Low Cost: Every time we buy and sell stocks we need to pay a charges (like brokerage, taxes, etc). It means, the frequent are our transactions more will be the cost associated with it. Hence it is always more efficient to buy in bulk and hold for long-terms. Moreover, income tax laws are more favourable for long-term capital gains as compared to short-term (read more about tax rules).Q3: Is it always good to hold stocks for the long term?While long-term investing has its merits, it isn’t always suitable for every stock. Here are important factors to consider:3.1. Fundamentals MatterNot all stocks perform well over time. For long-term investing to be effective, the company’s fundamentals must be strong. Businesses in sectors like Healthcare, can shown consistent revenue growth of 9.7% YoY. Even Financials, which is forecasted to grow at 12.4% YoY in Q2FY25 , are better suited for long-term holding.The best example to explain the long-term holding’s effectiveness can be stocks of Metal & Mining sector. It is a cyclical sector. It said that their earnings may decline like 32.4% YoY. So people who plans to buy this stocks now for short-term might see losses. But people who will accumulate quality stocks of this sector in these times, and stay patient, will see good growth over long term. 3.2. Business Life CycleCompanies, like all businesses, have life cycles. Not every company will grow consistently for 10 years.As a stock investor, we must understand that companies, like living organisms has a life cycle. They cannot grow perpetually. Just as trees cannot grow to the sky, businesses face constraints imposed by market saturation, innovation cycles, and operational complexities.As a company matures, its initial rapid growth often slows. It is not merely due to external competition or market exhaustion, but from internal dynamics. When companies become too big, it also breeds bureaucracy, decreases agility, and dilutes the entrepreneurial spirit that once fueled its expansion. This life cycle acts as a natural governor, reminding us that growth is not infinite. When a company is growing fast, it is a phase. It is followed by maturity, and eventually, decline or reinvention.3.3. Market DisruptionsDisruptions in the market, such as technological innovations or regulatory changes, can significantly impact certain sectors.IT companies, for example, face risks from automation, geopolitical issues, and changing client preferences.While many businesses adapt, some may not survive, making long-term holding riskier for certain stocks.3.4. Management Quality and Business StrategyA company’s ability to thrive over a long period heavily depends on its management’s strategic decisions.Companies like HDFC Bank and ICICI Bank, with solid management and growth strategies, can be held for a long-term.However, businesses with weak management or poor strategic direction may fail to deliver returns over time.3.5. Valuation MattersIt’s important to buy stocks at a reasonable valuation for long-term success. Overpaying for a stock, even a good one, can limit future returns.We have seen how the Midcaps and Smallcaps have seen valuation increases in the last two years. In most of these stocks, the margin of safety has been eroded almost completely. Investing in such overpriced stocks, even for the long term, can lead to disappointing results.Long-term stock holding is beneficial, but it’s crucial to invest in fundamentally sound companies, at the right valuation. To ensure growth, we must invest in sectors with growth potential.Not every stock is suited for a long-term horizon, and careful selection is key.Q4: When we say Long Term investment, what is the duration we generally hold with that stock?In the context of long-term investing, the typical duration of holding a stock is often considered to be 10 years or more. This is the reference-period I always keep in my mind.This period allows investors to benefit from the compounding effect of earnings and dividends. As the underlying business grows over long-term, it also pulls its stocks-up with itself.Why 10 Years?Time to Ride Out Volatility: Over a shorter period, the stock market is highly unpredictable due to macroeconomic factors, company-specific news, and market sentiment. However, over a 10-year period, the performance of a stock is more closely aligned with the company’s actual financial health and growth. Sectors like Financials and Consumer Goods, which show resilience over time despite short-term fluctuations, are more likely to perform well in the long run.Business Cycles: A 10-year period typically encompasses multiple phases of a company’s business cycle, including periods of expansion, downturn, and recovery. This duration allows investors to witness the company’s ability to manage various economic conditions. For example, BFSI, Metals, and cement has cyclical trends but generally grows in the long term. Our reference can be stocks like HDFC Bank, JSW Steel etc.Power of Compounding: Compounding requires time to show its full potential. Holding a stock for 10 years allows reinvested profits (retained earnings) to compound. Moreover, when we reinvest our dividends income, it also gets time to compound separately. A combination of reinvested profits and dividends compounding can significantly boost the total returns our our stock portfolio. Companies in the Consumer Staples sector (e.g., Hindustan Unilever ), provide both price appreciation and dividend growth over long periods.Growth at a Reasonable Price (GARP): Themes like “Growth at a Reasonable Price” are ideal for long-term investing . These stocks may not show immediate gains, but over a decade, their steady growth and reasonable valuations can deliver strong returns.Q5: How do beginners choose stocks for long term? How to select stock for the long term?Choosing the right stocks for long-term investment can be challenging for beginners. But by focusing on fundamentals and a disciplined strategy, it’s possible to build a robust portfolio.Allow me to present to you summarized guide to help you select stocks for the long term:Step #1. Look for Strong FundamentalsA company’s fundamentals are crucial for long-term success. These include its earnings growth (PAT and EPS), return on equity (ROE), and strong balance sheet (high liquidity, low debt, and high ROA).Sectors like Automobiles and Healthcare, generally exhibit consistent earnings growth. For instance, Bajaj Auto is expected to see a 20% YoY increase in PAT. This kind of earnings expansion can make it a solid candidate for long-term holding. I think, a similar such candidate is also Polycab. But in both these cases valuations is a concern.Earnings Stability: Companies with stable and growing earnings are more likely to perform well over time. Stocks in the Healthcare sector, like Dr. Reddy’s, benefit from stable demand and are less cyclical. Such stability is key for long-term investing.Return on Equity (ROE): A high and consistent ROE indicates efficient use of shareholders’ capital. HDFC Bank, with strong financial performance, is an example of a company with a high ROE, making it a good long-term candidate .Step #2. Focus on Sectors with Long-Term Growth PotentialInvesting in sectors that are expected to grow over the next decade is essential. IT, Telecom, and Healthcare show promising growth trends.The IT sector: Despite some short-term challenges like weaker discretionary spending , is anticipated to thrive long term due to digital transformation trends. Midcap stocks like Persistent Systems, Tanla Platforms, etc is expected to grow faster in decades to come. Their larger peers like TCS, Infosys may not grow as fast.Telecom is another sector with growth potential. It is driven by increasing data consumption. Stocks like Bharti Airtel, which is expected to see revenue growth , are attractive for long-term investors. But a big hitch with this sector is regulatory interventions. This is one reason why, I try to stay away from this sector.Step #3. Avoid Overvalued StocksBeginners often make the mistake of chasing popular or overhyped stocks. However, it’s important to focus on valuation.Even strong companies can deliver poor returns if bought at inflated prices.Midcaps and Smallcaps have become expensive recently, reducing their margin of safety. Buying such stocks at these price levels, can expose us to future price corrections.Thus, buying a stock at a reasonable price is crucial for long-term success.Step #4. Look for Dividend-Paying StocksStocks that pay dividends provide a steady income stream, which can be reinvested to compound returns.Companies in sectors like Consumer Staples and Utilities often pay regular dividends. For instance, Hindustan Unilever offers stable dividends, making it an ideal stock for long-term investors who want both capital appreciation and regular income.Consistency in Dividend Growth: Ensure that the company has a history of consistently increasing its dividends. This indicates financial health and management’s commitment to returning value to shareholders.Step #5. Pay Attention to Management QualityThe quality of a company’s management is a key determinant of its long-term success. Companies with visionary leadership tend to outperform their peers.For example, HDFC Bank and ICICI Bank, which are guided by strong management teams, have consistently delivered good returns .Beginners should look for companies with strong leadership and a proven track record of sound decision-making.Step #6. Diversify Across SectorsDiversification is crucial for managing risk.Beginners should not put all their money into one sector or stock.A balanced portfolio approach by highlighting the performance of multiple sectors, such as Financials, Healthcare, and Telecom . Diversifying across these sectors ensures that if one underperforms, the others can potentially offset the losses.Step #7. Keep a Long-Term MindsetPatience is critical in long-term investing.Beginners should avoid checking stock prices frequently or reacting to short-term market news.Companies like Asian Paints or Britannia, which may experience quarterly volatility, typically perform well over a 10-year period.ConclusionBeginners can choose long-term stocks by focusing on strong fundamentals.Invest in sectors with growth potential, reasonable valuations, dividend payers, and companies with quality management.Have a happy investing.