“Do Stocks Outperform Treasury Bills?,” asks Arizona State University’s Hendrik Bessembinder. Well played, professor. The reply to the headline’s question surely can’t be yes, because that would be no story at all; everybody knows that stocks beat Treasuries. But how could it be no? Everybody knows that stocks beat Treasuries.
So much for what we know. Bessembinder’s verdict: “Most common stocks do not outperform Treasury bills.” Well now. Even those who make a living by studying stock-market returns were taken aback by that comment, and by the data that followed. Wes Gray, who holds a University of Chicago doctorate in finance, regards this result as “exciting, new, and intriguing.” With that assessment, I fully agree.
To be sure, the direction of the paper’s finding is not new. Because of the effects of compounding, the median return on stocks that are held for a long time is less than the average return. This point is simple. The most money that a stock can lose is 100% of the initial investment. In contrast, the most that it can gain is infinite. True, its actual performance will be finite, but over time the cumulative growth can be enormous.
In other words, if Green Mountain Coffee Roasters rose 9,211% for the first decade of this millennium (as it did), yet the stock market overall declined (as it did), then a great many corporate duds must have offset Green Mountain’s success. The only mathematical path to make the numbers work out is for the mean to be larger than the median.
However, while the paper’s direction was predictable, its power was not. It is one thing to realize that stock returns are positively skewed. It is quite another to learn that most stocks, on most occasions, have been poor investments. A few huge winners, several modest winners, and whole lot of flops—such has been the history of the U.S. stock market.
The study was conducted using the comprehensive Center for Research in Securities Prices database, for the period 1926-2015.
Against the Odds (Short Version)
A stock’s monthly return was positive 48% of the time.
Throw a dart at the study’s 1080 months, selecting one month at random. Then do the same for all stocks contained in CRSP’s database. Odds are, that security lost money on the month. That’s correct: A random, one-stock experience of the U.S. stock market would have been likelier to end in losses than in gains. That finding directly contradicts what I have often written, which is that stocks rise more often than they fall. My statement remains correct, as long it’s understood that “stocks” is shorthand for “the stock market overall,” or at least “a large pool of securities.”
Against the Odds (Long Version)
A stock’s lifetime return was positive 49% of the time.
Whoa. What? It was disconcerting to learn that a single stock was likelier to lose money than gain during any given month, but that was after all only for a short time. And we know that stocks should be held for the long haul. Presumably, even though they suffer small dings during their losing 52% of months, they make enough hay during the winning 48% that they turn a profit over the long term. Haven’t I just been writing about positive skew? That’s what positive skew means—the gains outweigh the losses. Yet there’s no apparent positive skew here. Over the companies’ entire stock-market existence, their batting average was barely better than over a single month.
Have you guessed why? The reason is because the winning companies consume the skew. Plot the monthly returns for all stocks, and there are many points on the graph’s far right, enormous gains that would pump up a stock’s cumulative totals, thereby erasing a host of mildly negative down months. But—here’s the catch—those gains aren’t randomly distributed. And distressingly, many of those businesses die hungry, with their stocks having recorded negative returns for their lifetimes. Rest in peace.
The Few, the Brave
Half of U.S. stock-market wealth creation has come from 0.33% of listed companies.
Please note, that figure is not 33%. It is one third of 1%—one security out of 300.
To be clear, this measure is somewhat different in nature than the previous two. They addressed the typical stock, meaning that each security was equally weighted for the calculations. The big firms did not count more than the small ones. With this third statistic of wealth creation, however, size very much does matter. No matter what their performance, tiny companies can’t meaningfully increase the overall value of the U.S. stock market. That feat is accomplished by the giants.
Eighty-six of them, to be exactly. Of the 26,000 stocks that appear in CRSP’s database, 86 provided half the aggregate wealth creation, 282 are required to reach the 75% figure, and 983 account for the full 100%. That is, after the 983 highest wealth creators, the remaining 25,000-plus securities are net neutral. Some made money for their investors, and some lost, but overall they were a wash.
The More, the Merrier
Bessembinder draws the obvious lesson. “These results reaffirm the importance of portfolio diversification, particularly for those investors who view performance in terms of the mean and variance of total returns.” (Translation: Particularly for those investors who are sane, and who therefore seek the highest possible returns with the lowest possible risk.) Most stocks will be poor investments. However, assuming that the future roughly resembles the past, such that equities retain a return premium, most stock portfolios will do just fine. In other words, do as your columnist prescribes, not as he does: Diversify. Widely and broadly.