Most stocks lose money. How can that be? As almost all investors know, large-company stocks have returned, on average, an annualized 10.1% since 1926. But a fascinating new academic paper finds that virtually all of those profits can be attributed to fewer than 4% of all stocks.
Authored by Hendrik Bessembinder, a finance professor at Arizona State University, the paper (Do Stocks Outperform Treasury Bills? (opens in new tab)) holds an important lesson for investors — namely that if you want to make money in the stock market, you’d better either be close to psychic in your ability to pick stocks or you’ll need to own lots of them. And the best way to accomplish owning lots of stocks is by investing in index funds. (There should be an asterisk affixed to Bessembinder’s study, however, which we’ll get to in a minute.)
Bessembinder examined the returns of the 26,000 stocks in the Center for Research in Security Prices database, which contains all common stocks listed on major U.S. exchanges. He found that the average stock traded for just seven years and lost money (including reinvested dividends). In fact, the most common return for an individual stock over its lifetime was a loss of 100%. In other words, if you had invested in any one stock from 1926 through 2015, you would most likely have come away poorer. Only 48% of stocks delivered any gains.
Of the 26,000 stocks, a mere 1,000 have accounted for all of the profits in stocks since 1926. And just 86 stocks — one-third of 1% — were responsible for half of those gains.
Moreover, Bessembinder found that only 4% of stocks contributed all of the stock market’s gain that exceeded the return of supersafe, one-month Treasury bills. Academics typically measure investment returns against those of short-term Treasuries because they’re considered riskless. The other 96% of stocks, in aggregate, merely matched the return of one-month Treasuries, according to Bessembinder.
How can the market return such fat long-term returns while so many stocks don’t contribute any return over one-month Treasuries? “Simply put, very large positive returns for a few stocks offset the negative returns for more typical stocks,” Bessembinder says.
Here are the stocks that have made the most money. The biggest gainer is tobacco giant Altria Group (MO (opens in new tab)), which has returned 203 million percent over its lifetime (including predecessor companies) through 2015. Rounding out the top ten top performers: IBM (IBM (opens in new tab)), 94,564%; Coca-Cola (KO (opens in new tab)), 66,634%; PepsiCo (PEP (opens in new tab)), 42,284%; Bristol Myers Squibb (BMY (opens in new tab)), 34,848%; Johnson & Johnson (JNJ (opens in new tab)), 29,307%; Abbott Laboratories (ABT (opens in new tab)), 28,207%; Pfizer (PFE (opens in new tab)), 25,887%; ExxonMobil (XOM (opens in new tab)), 22,585%; and Chevron (CVX (opens in new tab)), 9,454%.
Bessembinder doesn’t attempt to explain why the big winners did so well, much less to predict future winners. But to me, it’s intriguing that four of the 10 stocks are health care stocks, which has long been my favorite sector.
The paper offers little encouragement to stock jockeys. Beating the market by picking a handful of stocks, Bessembinder says, is “lottery-like.” Ouch.
Years ago, stockbrokers often invested a client’s stock money in 15 or 20 stocks. Some still do. That was all that was necessary, the thinking went, to achieve returns that equaled or beat the market. Many individual investors have long invested using that same method. But if you believe Bessembinder’s research, that’s a dangerous strategy. Odds are, you won’t pick any of the big winners, and most of your holdings will significantly underperform their benchmark index.
The same goes for many mutual funds, which operate on the theory that good managers can eclipse index returns with a few dozen good stocks. A 2005 study found that the median actively managed fund held only 65 stocks. More recent studies have produced similar results. Bessembinder says his paper should “help to explain why active portfolio strategies most often underperform their benchmarks.”
There is one large caveat to Bessembinder’s work. Not surprisingly, volatile, small-capitalization stocks are much more likely to be losers. Among the bottom tenth of stocks by market cap, only 43% made any money over a 10-year holding period. By comparison, 80% of stocks with the largest market caps made money over 10-year periods and 70% outperformed one-month Treasuries.
Jeremy Siegel, a finance professor at the University of Pennsylvania’s Wharton School, voiced a blunt critique of Bessembinder’s study. “Why would you invest the same amount in a tiny stock rather than in Apple or Microsoft?” he asked in an e-mail. It’s ridiculous, he says.
Suppose Bessembinder redid his study and excluded stocks that sell for pennies a share, fly under Wall Street’s radar and, as the saying goes, “trade by appointment?” You could slice off, say, the bottom 30% or 40% of stocks by market cap, and you might come up with a totally different result. Beware the kind of stocks your brother-in-law is always touting as “can’t miss” — the stocks you’ve never heard of.
Bessembinder agrees that very small stocks are much more likely to fail and may have had an outsize impact on his study. But he also points out that many of the biggest contributors to the stock market’s gains over the years have started as tiny stocks. And large caps aren’t exactly covered in glory, with 56% of them, as well as 69% of small caps, failing to match their benchmark indexes.
Unfortunately, stocks seem to be getting less likely to make any money for investors. Bessembinder looked at returns over successive, nonoverlapping 10-year periods, starting with 1926 through 1935. Seventy-two percent of the stocks that went public in that early decade had positive lifetime returns. Of those stocks that listed between 1966 and 1975, 61% had positive lifetime returns. But among stocks that went public between 1996 and 2005, only 39% had positive returns over their lifetimes; for those listed between 2006 and 2015, only 42% of stocks made any money. Part of the reason may be that many more stocks have been introduced in recent decades.
The bottom line: Either invest in index funds, which own hundreds or thousands of stocks, or own a collection of actively managed funds that combined invest in hundreds of stocks. In the stock market, it seems, there are a lot more strikeouts than home runs—but the home runs tend to be grand slams.
Steve Goldberg (opens in new tab) is an investment adviser in the Washington, D.C., area.
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