There. I said it.
Well I stole it. Hendrik Bessembinder actually said it, in more academic terms, in his 2017 article “Do Stocks Outperform Treasury Bills?”. Hendrik is the Francis J. and Mary B. Labriola Chair in Competitive Business and Professor, in the Department of Finance, W.P. Carey School of Business, Arizona State University. Isn’t it funny how people who donate money to universities over in the States need to have their name in the title? I wonder how many people know what Frank Labriola did? (I looked him up — he sold his aluminium business to Alcoa).
Anyway. Back to rubbish investments. Hendo looked at US-listed stocks in the CRSP (The Center for Research in Security Prices) database between 1926 and 2016. Here’s what he had to say:
The majority of common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills. These results highlight the important role of positive skewness in the distribution of individual stock returns, attributable both to skewness in monthly returns and to the effects of compounding. The results help to explain why poorly-diversified active strategies most often underperform market averages.
“Positive skewness”. I don’t think I’ve ever seen that term before.
What does it mean? According to Hendo, it means that a few stocks have such large positive returns that they offset the rubbish returns of the rest of the market.
And he names names.
I calculate that the approximately 25,300 companies that issued stocks appearing in the CRSP common stock database since 1926 are collectively responsible for lifetime shareholder wealth creation of nearly $35 trillion dollars, measured as of December 2016. However, just five firms (Exxon Mobile [sic], Apple, Microsoft, General Electric, and International Business Machines) account for ten percent of the total wealth creation. The ninety top-performing companies, slightly more than one third of one percent of the companies that have listed common stock, collectively account for over half of the wealth creation. The 1,092 top-performing companies, slightly more than four percent of the total, account for all of the net wealth creation. That is, the remaining ninety six percent of companies whose common stock has appeared in the CRSP data collectively generated lifetime dollar gains that matched gains on one-month Treasury bills.
So just over 4% of the companies accounted for all of the stock market’s net wealth creation above Treasury bills. The other 96%, taken together, did no better than Treasury bills.
That doesn’t mean every one of those 96% was rubbish. Some did very well. But their gains were cancelled out by the ones that didn’t.
When Hendo looked at individual stocks, he found that about 57% failed to beat Treasury bills over their lifetimes. Including reinvested dividends.
Here’s the thing about that — PEOPLE WERE INVESTING IN THOSE STOCKS.
Not just people. Serious people. Fund managers. Professional investors. People getting paid gajillions of dollars a year to know what they are doing.
What does this mean for us as investors?
I’ve said it many times on the podcast, but I’ll say it again. QAV is a pretty simple idea. It tries to filter out the bad companies and leave us with good ones — businesses with quality financials that are trading at a reasonable price. And we figure that, on the balance of probability, that should give us a better chance of outperforming.
Not that we think we’re going to get it right 100% of the time. We work on the assumption that we’ll get around 60% right. There are too many variables that our model can’t predict — black swans, election results (I’m looking at you, Brazil), African dictatorships arresting CEOs, fraud, CEOs allegedly having affairs with their HR directors, etc.
But the percentage alone isn’t enough. Six small wins can be wiped out by four big losses. We also need our winners, collectively, to outweigh our losers. That’s why our selling rules matter, and why we don’t sell a stock just because it’s gone up. We want to stay with the winners while our rules say to hold them.
So that’s the simple idea at the heart of QAV. Most stocks are rubbish. Filter them out. Buy what’s left.
QAV Myth Killers is a weekly column in the QAV newsletter, taking apart a piece of
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