Hurco: A reminder to stick with buy and hold

Over the last month, most of our portfolios have taken major beatings along with the rest of the market (The Smart Guy Stocks portfolio has dropped over 10% from its high). Friday’s rally notwithstanding, the huge negative swings of the market in July and August have been enough to test any investor’s resolve.

It’s heart-wrenching to watch one of your stocks drop 30% when it misses earnings by a few pennies, or see the market decide that a technology company is suddenly worth 20% less because of mortgage lenders making some bad sub-prime loans (I understand the potential for the sub-prime crisis to affect the entire economy, but the recent huge drops in totally unrelated companies seems overdone). During times like these, I find myself invariably questioning the buy and hold approach, and ruing the fact that I did not successfully “time” the market and take my profits.

I assume that many of you, like me, are guilty of second-guessing your investment strategy during these rough patches. So I wanted to give all of us some anecdotal reassurance that buy and hold works. When I say buy and hold, this doesn’t mean just purchasing a stock and closing your eyes for five years - every investment should be diligently tracked and regularly reevaluated. Buy and hold means that you don’t sell your shares in a company until the reasoning behind your fundamental thesis (why you invested in the company in the first place) changes. Ala Warren Buffet, the disciplined buy and hold investor shouldn’t get scared by often random-seeming day-to-day or weekly movements; the idea is that the true value of a strong, growing company will be realized at some future point.

The company I want to look at is Hurco (Nasdaq: HURC), a small manufacturer of machine tools. Hurco has been one of the most successful holdings in my personal portfolio to date in 2007, up 50% for the year based on today’s closing price. It has also been one of the most volatile stocks: on three occasions, once each in February, May, and July, Hurco lost over 10% of its value in a week.

The reasons I have (and do) like Hurco are simple: earnings and revenue have been growing rapidly as the company looks to feed the insatiable appetites of the growing manufacturing markets of China and India. The company has a history of consistently generating solid cash flow, yet has managed to trade at a very modest valuation relative to its growth (sub-20 PE). So did anything happen this year to change my thesis? No- sales and earnings both increased by ~15% in the 2nd quarter (which precipitated one of the 10% dips), and over 30% in the 3rd quarter results released last week. The company hasn’t released any other major news to speak of. So in Buffet-esque fashion, I’ve gritted my teeth and held on to the stock during the random 10% price drops.

I appreciate that not all stocks will recover as quickly from their price dips as Hurco has. In the case of another company, it may not be a week or even a couple months; but if the underlying thesis remains strong, the rewards will eventually be there. As for Hurco, I am still hanging onto my shares. I’m not making it an official SGS recommendation at this price, as I’m not convinced that margin for safety is quite what it used to be. But keep an eye on it and look to buy the next time the market decides to inflict another arbitrary 10% blow.

Disclosure: SmartGuyAB is long HURC