Great ones

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  By Guest Blogger Doug Rowat

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If you bought Nvidia at the end of 2023, my congratulations.

As the business media has been endlessly highlighting, the stock is now up nearly 60% y-t-d. Any investor would be happy with this as a cumulative return over several years. Nvidia investors have achieved these gains in just a couple of months.

Sadly, I don’t own Nvidia myself. While I’m not jealous of those who do (perhaps, a bit jealous), I do take issue with those investors who attribute their ownership of the company purely to their stock-picking skill.

As Michael Mauboussin highlights in his book The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing, investors “commonly twist, distort, or ignore the role that luck plays in [their] successes and failures.”

In other words, investors routinely fail to distinguish results that are due to skill versus results that are due simply to luck. Behaviourally speaking, this is known as self-attribution bias: our tendency to incorrectly attribute positive outcomes solely to our own skill or talents.

I’ve highlighted the research of JP Morgan here before in emphasizing the risk of catastrophic portfolio failure (e.g., roughly 44% of the stocks in the Russell 3000 Index will experience, at some point, a permanent loss of 70% or more). However, what the JP Morgan research also shows is that 1) investors, overall, are much more likely to pick a disaster stock than an Nvidia and 2) a remarkably small number of stocks actually drive the Index’s overall return. JP Morgan has determined that the vast majority of the Russell 3000’s long-term gains come from only 7% of its constituents.

In the chart below, notice the tilt towards the left-hand-side columns. The catastrophic underperformers are far more plentiful than the shoot-out-the-lights outperformers. The chart reveals that, all things being equal, investors are more likely to select a badly underperforming stock than a strongly outperforming one:

Distribution of excess lifetime returns on individual stocks vs the Russell 3000, 1980-2020

Source: JP Morgan

Of course, the JP Morgan data only goes to 2020, but we can safely assume that the relationship still holds given the super-concentrated rise of the Magnificent 7, and more specifically Nvidia, in recent years.

Therefore, an investor who claims skill regarding their selection of Nvidia should examine the entirety of the evidence. For instance, have the majority of their other stock picks also strongly outperformed over time? Skill inevitably reveals itself when the sample size gets larger and the duration longer.

Peter Gzowski in his classic biography of Wayne Gretzky, The Game of Our Lives, identifies the nature of Gretzky’s extraordinary talent:

He distorts time, and not always by slowing it down. Sometimes he will release the puck before he appears ready, threading a pass through a maze of players precisely to the blade of a teammate’s stick, or finding a chink in a goaltender’s armour and slipping the puck into it before the goaltender is ready to react….. If he did not repeat their results so many times it would be possible to dismiss many of them as luck.

Positive results achieved repeatedly. This is always what distinguishes skill from luck. And, naturally, no one would ever attribute Gretzky’s success to anything other than skill. Put another way, if Gretzky were an investor, he would have found the Nvidias as consistently as he found an open Jari Kurri.

With respect to investor skill and the JP Morgan chart above, I’ve highlighted the following in the past:

…to consistently outperform, investors need to overweight these tiny slivers of index-driving stocks and do so repeatedly. Given these stocks always slim percentage of the overall index, the odds are overwhelmingly against an investor consistently doing this.

So, be honest. What do your long-term investment results actually say about your skill?

Are you, in fact, Wayne Gretzky or just another beer-league wannabe?

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.

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About the picture: “Attached is a picture of my whippet, Draco, in mid-stride,” writes Heather. “When Draco isn’t sleeping, he is running very fast and chasing things. He normally runs after his bright red frisbee. But, he hates cats. If we let him, he’d happily chase cats.”

To be in touch or send a picture of your beast, email to ‘[email protected]’.