90 Years, 90 Stocks, And One Big Lesson For Your Portfolio

90 Years, 90 Stocks, And One Big Lesson For Your Portfolio
Reda Farran, CFA

3 months ago5 mins

  • From 1926 to 2016, more than half of global stocks performed worse than simply holding cash, while a tiny minority of exceptional growth companies generated the bulk of stock market returns.

  • That’s why it’s smart for active investors to try to identify superstar stocks and back them for the long term.

  • Superstar stocks can come from any sector, but one thing they have in common is that the companies invest in research and development, while still achieving superior growth in returns, scale, and profitability.

  • For most portfolios, passive investing makes the most sense, a conclusion that’s also supported by Bessembinder’s research.

From 1926 to 2016, more than half of global stocks performed worse than simply holding cash, while a tiny minority of exceptional growth companies generated the bulk of stock market returns.

That’s why it’s smart for active investors to try to identify superstar stocks and back them for the long term.

Superstar stocks can come from any sector, but one thing they have in common is that the companies invest in research and development, while still achieving superior growth in returns, scale, and profitability.

For most portfolios, passive investing makes the most sense, a conclusion that’s also supported by Bessembinder’s research.

Mentioned in story

A few years ago, a finance professor at Arizona State University by the name of Hendrik Bessembinder published a paper with a remarkable revelation: just 90 companies – less than 0.4% of the total analyzed – were responsible for half the $35 trillion in shareholder wealth created by US stocks from 1926 to 2016. And whether you’re an active investor or a passive one, knowing where to find those superstars has big implications for your money.

What did Bessembinder find exactly?

Of the roughly 26,000 US stocks listed between 1926 and 2016, more than half lost money or performed worse than simply holding cash. By contrast, about 1,000 stocks – or just 4% of the entire sample – accounted for all the net shareholder wealth creation over the period, about $35 trillion. Put differently, the best-performing 4% of listed companies explain the net gain for the entire US stock market across those 90 years.

Source: Hendrik Bessembinder.
Source: Hendrik Bessembinder.

And it’s not just an American phenomenon: Bessembinder also found that around 60% of non-US stocks listed between 1990 and 2018 lost money or did worse for investors than simply holding cash. By contrast, less than 1% of those stocks accounted for the entire $16 trillion of net shareholder wealth created over the period.

What strikes me about the research is how stock market returns can be driven by dynamics that are similar to venture capital returns, in that a small number of superstar companies account for all the wealth created in that industry, while the rest are duds. The gains from those successful moonshots simply outweigh the losses from all those failures.

So what does this mean?

Bessembinder’s research shows that only a tiny minority of exceptional growth companies generate the bulk of stock market returns. So if you’re an active investor who researches and picks specific stocks that you think will beat the market, you’ll want to bear in mind how important it is to identify these “big winners” and back them for the long term.

That latter point is key: Bessembinder’s research makes it clear that what matters most is the long-term compounding of superstar companies’ share prices. So for active investors to benefit, they’ll need to have the patience to deal with the inevitable ups and downs that those stocks experience. Apple, for example, created $2.7 trillion of shareholder wealth between 1990 and 2020 – by far the highest of any global stock over that period. But during those three decades, there were two instances where Apple’s stock experienced a massive 80% drawdown – once over three years and once over almost seven.

This discipline of holding onto long-term winners is important not just when they’re in drawdown, but also when they’re shooting higher. Take Tesla: the EV-maker’s stock surged 740% in 2020, creating around $590 billion in shareholder value. And its stock shot up by another 50% in 2021, creating an additional $392 billion in shareholder value. It takes discipline not to cut and run when the going’s that good.

But the truth is that very few investors have the skills, resources, competitive advantage, and sheer luck to early-identify stocks that are poised to deliver outsized long-run returns. And because of that, Bessembinder’s research shows there’s a strong case to be made for passive investing – that is, buying funds that simply replicate the performance of the entire stock index. After all, when few firms account for the market’s overall gains, you’d do well to just buy the entire haystack, rather than scour for the needles buried in it.

What do the superstar companies have in common?

The table below shows the 50 global firms that created the most shareholder wealth between 1990 and 2020. They represent almost a third of the net global shareholder wealth created over the past three decades.

Source: Hendrik Bessembinder.
Source: Hendrik Bessembinder.

The first thing you might notice is that the top 10 stocks on the list are mostly growth stocks from the tech sector – no coincidence considering the calculations start in 1990, just before the internet took off.

Growth stocks are those expected to expand their earnings at a faster rate than the market average, and that trade at higher valuation multiples as a result. Historically, growth stocks have underperformed value stocks – i.e. stocks that look cheap relative to the market – because of our human inclination for optimism, which leads us to overpay for “lottery ticket” stocks. But the winner-takes-all dynamic of the modern digital economy could mean that those stocks pay off far more in the future than they have in the past, making investing in growth stocks a little more rational today.

After those 10 stocks, the list becomes a lot more diverse: there are energy majors (ExxonMobil, Chevron, Saudi Aramco), consumer firms (Walmart, Nestlé, Procter & Gamble), financial giants (Visa, Berkshire Hathaway, JPMorgan), healthcare companies (Johnson & Johnson, Roche, UnitedHealth), and more. And most of those wouldn’t be considered growth stocks. Energy majors, for example, aren’t expected to grow their earnings by much: they’re viewed as cash cows instead, generating lots of cash and distributing it to shareholders via dividends.

So when you’re looking for superstar stocks, don’t limit your field of vision to Silicon Valley. According to an analysis by investment firm Baillie Gifford, the tech sector produced fewer superstar companies than other sectors – like energy, telecoms, and utilities – when calculated as a percentage of all the stocks within the sector. The same analysis found that investing in research and development while still achieving superior growth in returns, scale, and profitability was a better determinant of winning companies.

So if you’re an active investor, that should give you a good starting point. And if you’re not, you can take comfort in Bessembinder’s research and keep on with your passive investing approach.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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