By LARRY SWEDROE
Highlighting the riskiness of individual stock selection, recent research has demonstrated that around the globe the majority of individual common stocks have generated long-run shareholder losses relative to a Treasury-bill benchmark. The implication is that the large, long-term equity risk premium delivered by the broad stock market was attributable to outsize gains generated by a relatively few high-performing stocks. For example, in his study Do Stocks Outperform Treasury Bills?, covering the period 1926-2015 and all stocks on the NYSE, AMEX and Nasdaq, Hendrik Besssembinder found that:
- From the beginning of the sample or first appearance in the data through the end of sample or delisting, and including delisting returns when appropriate, just 42.1 percent of common stocks had a holding period return greater than one-month Treasury bills.
- Over their full life, only a minority (49.2 percent) of common stocks had a positive lifetime holding period return, and the median lifetime return was -3.7 percent.
- Even at the decade horizon, a minority of stocks outperformed Treasury bills.
- Despite the existence of a small-cap premium (an annual average of 2.8 percent), just 37.4 percent of small stocks had holding period returns that exceeded those of the one-month Treasury bill. In contrast, 69.6 percent of stocks in the largest decile outperformed the one-month Treasury bill.
- Reflective of the positive skewness in returns, 3.8 percent of single-stock strategies produced a holding period return greater than the value-weighted market, and only 1.2 percent beat the equal-weighted market over the full 90-year horizon.
Jiali Fang, Ben Marshall, Nhut Nguyen and Nuttawat Visaltanachoti found very similar evidence in their study Do Stocks Outperform Treasury Bills in International Markets?, published in the May 2021 issue of Finance Research Letters. Their data sample covered more than 70,000 stocks in 57 countries over the period 1996 through 2017. Following is a summary of their findings:
- More than half the common stocks in the majority (55 of 57) of international equity markets generated total returns that were less than local Treasury bill returns.
- The average cross-country proportion of stocks that outperformed was 42.4 percent.
Expanding on his earlier work, in his June 2021 study, Stock Market Winners: Conditional Probabilities, Elapsed Times, and Post-Event Returns, Hendrik Bessembinder examined the performance of “winner” stocks. He defined winner stocks as those that had achieved a five times gross return from a prior low. He then identified those that repeated the 5x performance one, two or three times such that their cumulative gross return relative to the original low point reached 25x, 125x and 625x, respectively. He then sought to answer the following questions:
- Are the majority of gains to the few “winner” stocks concentrated in sharp run-ups or more moderate rates of price appreciation spread out over longer horizons?
- What is the probability that a stock that achieves a certain cumulative gross return multiple (such as 25 times) will go on to achieve a subsequent multiple (such as 125 times)?
- What are the returns that accrue on average in the months after stocks reach these gross return benchmarks?
Bessembinder’s data sample included the 25,775 common stocks traded on the major U.S. stock exchanges and covered by the Center for Research in Security Prices (CRSP) monthly common stock database between January 1973 and December 2020. His study included dividends and assumed they were reinvested. To assess the average performance of these “winner” stocks in the months before and after the event months (when they achieved the multiple return), he computed both equal-weighted and value-weighted average returns for event stocks for each month, from 119 months before the event month to 120 months after the event month — the return to a “winner” portfolio. Following is a summary of his findings:
- 11,442 stocks, 44 percent of the sample, achieved a 5x multiple relative to a prior low point at some time during the 48-year sample period.
- Among those that reached a 5x multiple, 29 percent (3,306 stocks) went on to achieve a 25x multiple relative to the same prior low point. The stocks that reached 25x comprised about 12 percent of the full sample.
- A total of 955 stocks achieved a 125x multiple, less than 4 percent of the full sample.
- 271 stocks, 1 percent of the full sample, achieved a 625x multiple.
- The mean times between successive events for this sample were 68 months from 5x to 25x, 70 months from 25x to 125x, and 56 months from 125x to 625x.
- Some stocks reached successive multiples quickly; the 10th percentile time from the 5x multiple to the 25x multiple was 20 months, while the 10th percentile time from 25x to 125x was 36 months and from 125x to 625x, 46 months.
- Perhaps surprisingly, larger stocks showed a higher propensity to reach subsequent multiples as compared to the full sample data. However, the elapsed time to achieve the multiple was greater for large stocks than for the full sample — the mean elapsed times after reaching 5x to reaching 25x, 125x and 625x for large stocks that did so were 110 months, 138 months and 148 months, respectively, compared to 91 months, 127 months and 139 months for the full sample.
- A substantive proportion of the abnormal performance of the “winners” accrued prior to the calendar period that defined the event. For example, on 25x events, about half the return occurred in the calendar year that culminated in the event—implying that a significant portion of the unusual performance was spread out of over time.
Perhaps the most important finding was that there was little evidence of positive market-adjusted returns after the events. The authors noted: “For the value-weighted portfolio, the geometric mean market-adjusted annual return for the ten post-event years is -0.25% for 5x events, 0.34% for 25x events, -0.74% for 125x events, and 1.61% for 625x events. While the last of these is a non-trivial figure, as it compounds to 17.32% over ten years, it is based on a small sample of just 88 events.”
His findings led Bessembinder to conclude that “winner” stocks are not uncommon in the U.S. markets. However, he noted that his findings reveal “little or no evidence that a strategy of investing in those stocks that previously attained a given gross return multiple generates abnormal returns during subsequent months. Stated alternatively, the fact that some stocks generate outsize long-run returns does not imply that the markets are characterised by a form of long-horizon return momentum that can be exploited by simply purchasing stocks with large prior price run-ups.
To be successful, investment strategies that involve concentrated portfolio positions require the ability to reliably discern between stocks where the current market price fully incorporates the firm’s future potential versus those that do not.” And the lack of persistence of performance of active managers, as evidenced in the annual S&P Active Versus Passive Scorecards (SPIVA), demonstrates that the ability to discern future winners is a scarce commodity. And as demonstrated by Andrew Berkin and I in our book The Incredible Shrinking Alpha, the task has become increasingly difficult over time.
Most common stocks do not outperform Treasury bills over their lifetimes. The research findings highlight the high degree of positive skewness (lottery-like distributions) and the riskiness found in individual stock returns. The implication is striking: while there has been a large equity risk premium available to investors, a majority of stocks have negative risk premiums. This finding demonstrates just how great the uncompensated risk is that investors who buy individual stocks (or a small number of them) accept — risks that can be diversified away without reducing expected returns.
Such results help explain why active strategies, which tend to be poorly diversified, most often lead to underperformance. At the same time, the results potentially justify a focus on less-diversified portfolios by investors who particularly value the possibility of lottery-like outcomes despite the knowledge that the poorly diversified portfolio will most likely underperform.
The results from the studies we have examined serve to highlight the important role of portfolio diversification — which is said to be the only free lunch in investing. Unfortunately, most investors fail to use the full buffet available to them!
The information presented herein is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information may be based on third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Performance is historical and does not guarantee future results. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth® or Buckingham Strategic Partners® (collectively Buckingham Wealth Partners). LSR-21-121
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.
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