Why Most Stock Picks Disappoint
- Marius
- Sep 28
- 7 min read
If your portfolio largely consists of a few stocks, or if you are a stock picker, you might want to know your odds of success versus a total wipeout.
Quiz time: How many of these questions can you get right?
What percentage of global stocks did better than the market average from January 1990 to December 2020?
A) 29%
B) 50%
C) 71%
What percentage of global stocks lost money for investors over the same 30 years?
A) 52%
B) 26%
C) 13%
What percentage of stocks in the Russell 3000 index suffered a -70% return without recovery from 1980 - 2020?
A) 11%
B) 22%
C) 44%
Which of these stocks created the most wealth for shareholders from 1926 - 2023?
A) Altria (formerly known as Philip Morris)
B) NVIDIA
C) Vulcan Materials
If you had to guess, what's the most likely buy and hold outcome for any single stock?
A) It doubles your money.
B) It goes to zero.
C) It roughly matches the overall market return.
Expand for answers
A, A, C, A, B
Most stocks are losers
We invest in stocks because we expect to earn a positive return on our investment, yet most stocks turn out to be losers. It is important to buy groups of stocks.
Research on 65,000 stocks worldwide by Hendrik Bessembinder showed 52% of all stocks lost money for investors in the 30 year period from January 1990 to December 2020. They reported similar numbers for a variety of geographies and time horizons.
Stock investors do so with the intention to outperform safer investments. Settling for a small positive retun is not good enough. If you're picking stocks, you're probably tying to outperform a simple index fund. The odds of success become much worse. Only 29% of stocks worldwide outperformed the market over the full time period.
Table 1: Buy and hold returns of stocks from 1990 - 2020 with dividends reinvested
% with positive return | % beating the market | |
|---|---|---|
Global Stocks (Monthly Horizon) | 49.4% | 45.9% |
Global Stocks (Annual Horizon) | 51.9% | 43.2% |
Global Stocks (Decade Horizon) | 50.6% | 35.4% |
Global Stocks (1990 - 2020) | 48.2% | 29.3% |
North America Stocks (Monthly Horizon) | 49.7% | 47.5% |
North America Stocks (Annual Horizon) | 54.2% | 46.4% |
North America Stocks (Decade Horizon) | 52.7% | 40.7% |
North America Stocks (1990 - 2020) | 49.5% | 36.6% |
Source: Bessembinder, Hendrik (Hank) and Chen, Te-Feng and Choi, Goeun and Wei, Kuo-Chiang (John), Long-Term Shareholder Returns: Evidence from 64,000 Global Stocks (March 6, 2023). Financial Analysts Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3710251 or http://dx.doi.org/10.2139/ssrn.3710251
Market returns are skewed
The stock market as a whole nets a strong positive return for investors, yet most stocks lose money, and the vast majority underperform the average. Market returns must therefore be carried exclusively by a small number of big winners. We call this positive skewness.
You might be familiar with the bell curve of a normal distribution, where outcomes are equally balanced on both sides of some average. Stock returns are not normally distributed.
Stock returns are positively skewed. A large number of outcomes have small or negative returns, and a minority of outcomes are spread over a large range with stunningly high returns. Stock returns positively skewed because they are capped on the downside at -100%, but there is no limit as to the upside. Gains for the most successful stocks can exceed +30,000% over time.
Notice how the returns of most stocks are on the left side of the chart. This is a positively skewed distribution.
Positive skewness makes it exceedingly difficult to pick the few stocks that make money. However, the rewards for making the right picks are astronomical. If you're going to limit your portfolio to a small number of stocks, you better have a system that empirically works. Trading on news, a hunch, or even a compelling story is not good enough.
Volatility is such a drag
Another force conspiring against stock pickers and those with overly concentrated portfolios is volatility drag.
We previously wrote about how volatility drags down compound returns over time. To recap, imagine a stock that goes up in value by 50% one day, then drops by 50% the next day. The average return is 0%, but you would have lost 25% of your initial investment. The difference is called volatility drag. The higher the volatility (the amount by which stocks go up and down) the worse your long-run outcome.
Portfolios concentrating their holdings in just a few stocks have a higher volatility than a diverisifed portfolio with many stocks. The higher volatility translates into poor long-run performance. This is one of the reasons you see fewer stocks beating the market as the time horizon increases in Table 1.
Volatility drag creates more positive skewness. A very small number of stocks consistently outperforming the market create the vast majority of shareholder wealth over time. The long-term winners are the stocks that eke out modest incremental gains over a long period of time.
Bessembinder's 2024 report, Which U.S. Stocks Generated the Highest Long-Term Returns?, shows the inverse relationship between annualized (single year) returns and long-run cumulative returns.
Stocks with "extremely high annual returns never persist over longer horizons." Stocks with the largest cumulative returns create massive wealth through moderately high gains for many years.
The highest cumulative return was produced by Altria Group, the tobacco company formerly known as Philip Morris. A buy-and-hold strategy, reinvesting dividends, buying December 31, 1925 and holding through December 29, 2023 would have produced $2.65 million per dollar initially invested. In a distant second place is Vulcan Materials, a producer of construction aggregates, crushed stone, sand, and gravel. These businesses are hardly exciting.
Table 2: Firms with the highest cumulative returns do so over many years at steady annualized gains. Firms with the highest annualized returns get fewer years and lower cumulative returns.
Company Name | First Return Date | Last Return Date | Years | Cumulative Gross Wealth Per Dollar Invested | Cumulative Compound Return | Annualized Compound Return |
Altria Group | 31-Dec-1925 | 29-Dec-2023 | 98 | $2,655,290 | 265,528,900% | 16.29% |
Vulcan Materials | 31-Dec-1925 | 29-Dec-2023 | 98 | $393,492 | 39,349,084% | 14.05% |
NVIDIA | 22-Jan-1999 | 29-Dec-2023 | 25 | $1,316 | 131,500% | 33.38% |
US Robotics | 11-Oct-1991 | 12-Jun-1997 | 5.67 | $25.61 | 2,461% | 77.12% |
Gemini Energy | 16-Jan-1990 | 23-Apr-1991 | 1.27 | $10.23 | 923% | 526.17% |
Source: Bessembinder, Hendrik (Hank), Which U.S. Stocks Generated the Highest Long-Term Returns? (July 16, 2024). Available at SSRN: https://ssrn.com/abstract=4897069 or http://dx.doi.org/10.2139/ssrn.4897069
Big winners can’t hang on forever
Many high-net-worth investors are wealthy precisely because they hold a concentrated stock position that did well. Do stocks in the upper echelon stay there? No.
Bessembinder’s 2021 report, Long-Run Stock Market Returns: Probabilities of Big Gains and Post-Event Returns, shows no long-term persistence after big gains. Once a stock achieves its first 5x gain, the probability of a repeat performance is only 28%. Of the stocks that achieved 25x, only 28% of those go on to earn another 5x, achieving 125x. Of the few stocks that achieve 125x, only 28% again finally achieve 625x gains. The probability of a big gain is generally constant regardless of a stock’s history.
Table 3: Number of stocks that achieve repeated 5x gains from 1973 - 2020
Sample | Achieve 5x | Achieve 25x | Achieve 125x | Achieve 625x |
All Stocks | 44.39% | 12.83% | 3.71% | 1.05% |
Stocks having achieved 5x | 28.89% | 8.35% | 2.37% | |
Stocks having achieved 25x | 28.89% | 8.2% | ||
Stocks having achieved 125x | 28.38% |
Source: Bessembinder, Hendrik (Hank), Long-Run Stock Market Returns: Probabilities of Big Gains and Post-Event Returns (December 27, 2021). Available at SSRN: https://ssrn.com/abstract=3873010 or http://dx.doi.org/10.2139/ssrn.3873010
In their 2023 paper, Underperformance of Concentrated Stock Positions, Antti Petajisto looks at stock returns from 1926 to 2022 and also finds that individual stocks tend to underperform the market. No surprise there. What's new is the finding that stocks among the top 20% in the past five years, lagged the median stock by 10% after ten years.
The odds of a winning streak to continue get smaller over time while, creating the setup for a hard fall.
Agony follows ecstasy
JP Morgan Asset Management’s The Agony & the Ecstasy report from 2021 shows 44% of stocks in the Russell 3000 index suffered a catastrophic loss between 1980-2020. They define a catastrophic loss as “a 70% decline in price from peak levels which is not recovered.”
Their revised report from 2024 investigates whether catastrophic loss is predictable by looking at several factors involved with each loss. Their findings:
“Catastrophic declines come in all sizes and fall fast.”
The sector with the most catastrophes was healthcare / biotech followed by IT and consumer discretionary.
The sectors with the fewest catastrophes were utilities and energy.
Profitability was not a strong predictor. 54% were profitable.
Low debt levels didn’t help either. 63% had net debt-to-EBITDA of 2x or less.
Most catastrophes happened while the stock had forward P/E multiples between 10 and 50. Companies showed no signs of distress or irrational exuberance at the peak.
Wall Street analysts made the wrong calls. Most catastrophes were preceded by a “Strong Buy” rating from analysts. Analysts expected half of all decliners to have room for more growth.
Quit while you’re ahead
Let’s recap the numbers so far:
The chance of a stock pick outperforming the market index is roughly 29%. Gains for few winners are high and pull the averages upward.
It’s slightly worse than a coin toss as to whether a stock will have a positive or negative return in most time horizons up to 30 years.
There’s no long-term advantage to holding big winners, and they may be setting up for a catastrophic loss.
44% of stocks experience a catastrophic loss over 40 years.
What happens to the wealth in any single stock if you hold it and keep playing the same odds over and over? Bessembinder’s study of 65,000 stocks finds the most common long-run outcome for a single stock is the nearly total destruction of wealth.
Protecting your capital
The first rule of investing is “Don’t suffer devastating losses.” The second rule of investing is “Remember the first rule.” It's basically the Hippocratic Oath. First, do no harm.
Capital preservation is not mutually exclusive to achieving high growth. It is a pre-requisite. Avoiding extreme volatility lets compounding do its work.
That is the mindset we apply to our portfolios. We prioritize tax-efficient diversification whenever a client comes in with concentrated and highly appreciated positions, or if our investment strategy produces a big winner.
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