Last Updated on January 11, 2023
Stock picking is difficult because only a small minority of the stocks contribute to the majority of the gains. It’s skewed to only a few outliers. It’s as simple as that.
Let’s look at some facts:
Most stocks don’t beat Treasury Bills:
Hendrik Bessembinder became pretty “famous” for his study published in 2017 called Do Stocks Outperform Treasury Bills? The study shows that the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively just matched Treasury Bills. In other words, choosing stocks randomly means 96% of the stocks would return the same as Treasury Bills during its listing. With these odds, it goes without saying picking stocks is very difficult, to say the least:
- Only 42.1% of common stocks have a lifetime return that exceeds short-term Treasuries from 1926 to 2015.
- About 50% of stocks deliver negative lifetime returns.
- The median (not average!) life of an individual common stock is only seven years.
- 96% of Monte Carlo simulations underperformed a value-weighted index, 99% underperformed an equal-weighted index and 72% underperformed short-term Treasuries.
- In other words: the results are skewed to just a few stocks. Out of 26 000 stocks, just 86 were responsible for over half the value creation. 1000 stocks accounted for all wealth creation above Treasury Bills. It’s the few outliers that make all the returns, not the average or median stock. Large capitalization stocks had much more staying power, and consequently a much better chance of beating Treasury Bills over a decade.
What about sectors?
Bessembinder recently published a new study called Extreme Stock Market Performers, Part II: Do Technology Stocks Dominate? The study sheds light on the firms that generated extreme positive shareholder returns since 1950, but also the ones with the extreme negative outcomes. The stocks were divided into sectors to see internal performance within the sectors.
The results are mixed, but in some sectors, the median stock performs much better than in other sectors. For example, tech stocks are more likely to be on the worst list than on the top list. There are simply many “losers” among tech stocks, perhaps not so surprising considering that many of them either hit the dust or make it big. The survival rate is low. In contrast to tech stocks, we have more stable sectors like energy and healthcare where the median stock fares much better than in tech stocks. Among these two sectors, you are more likely to pick stocks with acceptable returns.
The table below shows the performance of the top 200 and bottom 200 by decade, ie. the accumulated performance over a period of 10 years. The rows contain the percentage number of firms either making it to the top or bottom and in which sector they belong:
|Top 200 firms||Top 200 firms||Bottom 200 firms||Bottom 200 firms|
|Percent of||Percent of||Over- or under||Percent of||Over- or under|
|“non-200”||top 200 firms||representation||bottom 200 firms||representation|
|firms in||in industry||relative to||in industry||relative to|
|Healthcare & pharmaceutical||8.83||14.15||60.2||6.35||-28.1|
|Wholesale and retail||12.7||10.06||-20.8||12.7||0.0|
For example, consumer durables have 1.42% of the 200 winners, compared to 23.27% for tech stocks, but only 0.79% of consumer durables are in the bottom compared to 30.16% for tech stocks. Clearly, some sectors are more stable than others. For every Intel or Google, there are many not making it.
Boring is, after all, good?
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