The picker’s penance

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  By Guest Blogger Sinan Terzioglu

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Hendrik Bessembinder, a finance professor at Arizona State University, has produced some of the most insightful research on the long term returns of stocks.

In his most recent report, Bessembinder analyzed the performance of 29,078 publicly traded US common stocks listed in the Center for Research in Security Prices (CRSP) database, covering the period  from 1926 to the end of 2023, to identify which stocks generated the highest returns. Similar to his earlier research, this report underscores the significant risks associated with investing in individual stocks and emphasizes the importance of diversification.

Key findings of the report:

• The average cumulative return for all stocks in the study over the 98-year period was 22,840%
• 51.64% of all stocks realized negative compound returns and the median outcome was a cumulative compound return of -7.41%
• The average period these stocks appeared in the CRSP database was just 11.60 years, with a median sample lifetime of 6.8 years
• Only 31 stocks were in the database for the entire 98-year period
• 17 stocks delivered cumulative returns greater than 5 million percentAltria Group achieved the highest cumulative return over the period, amounting to 265 million percent
• Nvidia achieved the highest annualized return among stocks with at least 20 years of return data, averaging 33.38% per year

This report reaffirmed Bessembinder’s previous findings, which showed that a small percentage of high-performing stocks significantly boosted the average cumulative return for all stocks, even though more than half of the stocks in the study lost value. Individual stock pickers are far more likely to choose underperforming stocks than successful ones.

The table below highlights the top 30 performers throughout the study:

Click to enlarge chart.

Bessembinder noted:

“One striking observation that can be drawn from the data in Table 2 is that the highest cumulative returns delivered by individual common stocks are attributable to annualized returns that are only moderately high. The median annualized return across the thirty stocks is 13.03%, while the mean is 13.05%.”

Over the past 100 years, the S&P 500 has generated an average annual return of approximately 10%, which is not significantly below the average annual return of the 30 stocks in the table. The key takeaway here is the significance of time in the market and the incredible power of compound growth, which requires patience.

Many investors fall into the trap of hindsight bias, where past successes seem obvious and easy to replicate. However, relying on past winners, assuming they will continue to perform well, can be misleading. For example, one of the big winners on the list, Walgreens Boots Alliance, has faced significant challenges in recent years. Due to deteriorating financial conditions, the company recently made a substantial dividend cut, ending a 47-year streak of annual increases. Investors who bought shares 10 years ago would currently be facing a 75% loss.

Identifying big winners early on is very challenging. 20 years ago, few could have predicted Nvidia’s rise as a major market outperformer because of its significant business evolution in recent years. Initially known for its graphics processing units (GPUs) for gaming, Nvidia has diversified over the past 8 years into areas such as Artificial Intelligence, data centers, and autonomous vehicles. This transformation was extremely difficult to foresee, as it required insight into emerging technologies, highlighting the difficulty of not only predicting long term winners but to also have the conviction to hold on to them during the inevitable large drawdowns.

Between 2000 and 2020, only 22% of S&P 500 stocks outperformed the index. During this period, the index generated a total return of 322%, while the median performance of the stocks in the index was 63%. This highlights the difficultly that both individual and professional investors have faced in attempting to outperform indices like the S&P 500 which will likely get even more challenging in the future.

One key reason is turnover: the S&P 500’s average annual turnover ranges from 2% to 5%, while institutional investors’ turnover ranges from 30% to 50%, incurring costs and taxes that reduce overall returns. The index allows top-performing stocks to stay and continue to their upward trajectory, whereas actively managed funds and individual investors often struggle to hold onto their stocks for the long term.

The most optimal strategy for most investors is to buy and hold diversified growth ETFs as part of a well-balanced plan until they achieve financial independence. This approach maximizes the chances of including the few stocks that become the largest wealth generators. Individual stock pickers who haven’t yet achieved financial independence take on significant risks, as underperforming picks can result in much more severe consequences than just missing out on the average market return. The opportunity cost of underperformance can significantly impact long term financial health especially for those that will be retiring without a pension.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.

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