Finding the few good apples getting harder and harder
A new academic study that suggests picking winning stocks is much harder than previously thought should cause asset owners to reconsider the balance of their equity portfolios between active and indexed management.
The study, by Hendrik Bessembinder of the W. P. Carey School of Business at Arizona State University, found that the majority of common stocks that have appeared in the Center for Research in Security Prices databases since 1926 have lifetime buy-and-hold returns that are less than one-month Treasuries.
Mr. Bessembinder wrote that "the best-performing 4% of listed companies explain the net gain for the entire U.S. stock market since 1926." The returns of all the other stocks collectively matched the return of Treasury bills.
The paper does not challenge the idea that stock markets provide long-run returns that exceed the returns of low-risk investments, but the evidence that is so is based on broadly diversified stock market portfolios.
Mr. Bessembinder examined the returns of individual stocks and found that most individual stocks provide buy-and-hold returns less than those earned on one-month T-bills. In fact, only 42.6% of common stocks have buy-and-hold returns, including reinvested dividends, greater than the return on one-month T-bills over the same time periods.
He found that just five companies out of the 25,967 studied accounted for 10% of the total excess return over T-bills over 90 years, and slightly more than 4% of the companies accounted for all of the excess return.
Mr. Bessembinder also examined returns decade by decade and found that the decade returns for most stocks were lower than the returns of T-bills. More concerning, returns have been declining in recent decades and stocks floated since 1977 had negative returns.
The study shows that more concentrated portfolios will underperform T-bills over the long run if they do not include the few stocks that generate returns in excess of T-bills. Identifying those stocks in advance is exceedingly difficult with so many choices.
Asset owners should read Mr. Bessembinder's study and consider the implications for their funds.