A Nail in the Stock Picker's Coffin

Briton Ryle

Updated April 19, 2017

I don’t often read 50-page research reports from finance professors. But when I do, I share the significant details with Wealth Daily readers. 

In this particular case, Arizona State finance professor Hendrik Bessembinder wrote a paper titled “Do Stocks Outperform Treasury Bills?”

This may seem like a silly question to pose. After all, with average annual gains of around 8% for the S&P 500 over the last 80 years, the answer seems obvious: Of course stocks beat Treasury bills. It’s no contest, right? Well, not so fast…

Now, I’m going to do something kind of dumb. I’m going to give you the answer right up front. Bessembinder’s research is another nail in the proverbial stock picker’s coffin.

We already know it’s virtually impossible for an active fund manager to beat the S&P 500 for more than a couple years running. So if you want beat fund managers and Treasuries alike without even thinking about it, you can stop reading now and just buy an S&P 500 index fund. 

BUT if you want some behind-the-scenes detail on exactly why it’s so hard for the stock-picking fund manager to beat the S&P 500 — and even beat Treasury bills — then I implore you to read on, because this is fascinating stuff.

To Diversify or Not?

First, let’s start with some rules. For his study, Bessembinder uses something called the CRSP database. The CRSP database provides monthly returns for every stock ever listed on the NYSE, Amex, and NYSE going back to 1926. There are 26,000 of them, so it seems pretty comprehensive.

We learned that these 26,000 stocks have created shareholder wealth of about $32 trillion. So it would seem obvious why the stock market would beat the Treasury market and equally obvious why investors should choose to invest in stocks.

Of course, it’s never that easy, is it?

The issue isn’t where to go for the best returns — that’s the stock market. It’s which stocks to choose.

To begin with, companies come and go. For those 26,000 stocks, the median time they are listed on an exchange is just seven years. Maybe they get acquired by another company, maybe they get taken private, or, in a few rare cases, maybe they get delisted. In any event, the window of opportunity for most stocks is not all that big. 

Still, the most surprising discoveries that Bessembinder made relate to the concentration of returns. It’s just a very few stocks that account for the vast majority of that $32 trillion in wealth creation. How few? I quote: 

Of all monthly common stock returns contained in the CRSP database from 1926 to 2015, only 47.7% are larger than the one-month Treasury rate. In fact, less than half of monthly CRSP common stock returns are positive. Of all monthly common stock returns contained in the CRSP database from 1926 to 2015, only 47.7% are larger than the one-month Treasury rate. In fact, less than half of monthly CRSP common stock returns are positive…

However, the eighty six top-performing stocks, less than one third of one percent of the total, collectively account for over half of the wealth creation. The 1,000 top performing stocks, less than four percent of the total, account for all of the wealth creation. That is, the other ninety six percent of stocks that have appeared on CRSP collectively generated lifetime dollar returns that only match the one-month Treasury bill…

In fact, just thirty six stocks were present in the database for the full ninety years.

You got that? Since 1926, just 1,000 stocks account for all of that $32 trillion in wealth creation. And half of that $32 trillion — $16 trillion — was created by just 86 stocks. The other 25,000 stocks did squat. Or maybe they even lost you money. And only 36 companies have been listed for the 90 years the study spans. 

I think we’re starting to see why it’s more difficult for stock pickers to beat the market. And it’s because at the end of the day, there just aren’t that many winners out there.

So what do with this information? 

Why You Have the Advantage 

A few things to cover here. First, when you see statistics like “half the S&P 500’s gain over the last year is due to gains in five stocks,” you know why. These days, investors and traders alike know that gains get concentrated in a small number of companies. And these companies get targeted. 

For the individual investor, it’s not a problem to own two or three stocks in a retirement account. Fund managers can’t do this. They have too much money, and they are slaves to one of Wall Street’s biggest myths: “diversification.” I mean, doesn’t this study show us clearly that diversification is not the panacea it is often made out to be? 

Also, this study does not account for dividends. I don’t know why, because dividends are absolutely critical for individual investors. Here’s a chart I share from time to time that shows you the power of companies that grow their dividends:

dividend perf

Companies that grow their dividends will make you money over time. Period. Get a Roth IRA, buy great companies that pay dividends, and you will do well.

Now, one more thing and I will let you go. 

I talk a lot about how to find great companies. So check this table out from Bessembinder’s paper. It is the top wealth-creating companies of all time. 

best cos all time

That’s a pretty good list of companies. How many have you never heard of? A couple, maybe? So, the companies that will make you the most money over time are not huge secrets. They are not hidden. They are names you see every day and make products you use every day. 

Finally, think in terms of innovation. What are the great inventions of the last 100 years? We have to go back 140 years for it, but the internal combustion engine was pretty big. So was the computer. And the smartphone. And the semiconductor. Modern medicine has saved untold lives and improved standards of living…

Now check that list again. Exxon, GM, Apple, Intel, Merck, Microsoft — these are some of your biggest winners. And they directly relate to American innovation. Follow the U.S. economy, pay attention to innovation, and you will find opportunity. 

Stay invested, my friends.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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