Morningstar - Q3 2021 - 12

Dispatches
How Many Stocks
Beat the Indexes?
Unlike the children of
Lake Wobegon,
most companies are
below average.
IVORY TOWERS
John Rekenthaler
In 2018, the Journal of Financial Economics
published the provocatively titled paper " Do Stocks
Outperform Treasury Bills? " by Arizona State
University's Hendrik Bessembinder. His answer:
Yes and no. Of course, the U.S. stock market
indexes had outgained cash; any Vanguard
500 Index VFINX shareholder could tell you that.
But those gains owed largely to relatively
few winners.
That paper received renewed attention this year,
when a Scottish firm cited Bessembinder's
research to justify its investment approach and
was promptly denounced in the Financial Times for
having crooned a " song for fools. " (Colorful
critics, those Brits.) The Financial Times' rebuttal
also downplayed Bessembinder's results,
accusing the author of having overstated his
case for dramatic effect.
This column will stick to addressing the facts,
not the portfolio debate. Is it true, as I believed
when I first encountered Bessembinder's
work, that most equities have returned less than
Treasury bills? Also, to what extent do the
market's higher-performing stocks drive the
results of the indexes?
Most Stocks Fail, Revisited
To respond to these questions, I updated
Bessembinder's findings by evaluating the results
of publicly traded U.S. equities over the
most recent decade, beginning in January 2011
12
Morningstar Q3 2021
and concluding in December 2020. EXHIBIT 1
shows the percentage of the 5,000 biggest
U.S. stocks (as of January 2011) that (1) ended
the 10 years with a gain, (2) recorded a loss,
or (3) disappeared from existence.
The numbers clearly support Bessembinder's
argument. Although the Morningstar US
Market Index enjoyed a 13.9% annualized gain
for the decade, only 42% of individual equities
finished in the black. Nearly as many (36%)
posted 10-year losses. The final 22% vanished.
While I did not investigate the fates of the
dead, Bessembinder's research suggests that half
the expired stocks were acquired, with decent
results, while the other half were delisted,
with dire consequences.
Even during a decade marked by an almost
uninterrupted bull market, the average stock
wasn't much good.
Separating the Fish
Then again, Amazon.com AMZN, Microsoft MSFT,
and ExxonMobil XOM aren't average
companies. Although he didn't dwell on the point,
Bessembinder's paper showed that larger
companies were significantly more reliable than
their smaller rivals. The major firms were
not only likelier to survive but also more likely to
profit when they did persist. To test whether
this pattern held through the 2010s, I separated
the stock data into two groups: the biggest
1,000 stocks and the next 4,000.
The larger companies were far more reliable
than their smaller rivals, as shown in EXHIBIT 2.
Whereas 42% of the overall stock universe
persisted for the full decade and posted a positive
total return, 77% of the biggest 1,000 companies
did so. Conversely, once the larger fish had
been removed from the list, the success ratio of
the next 4,000 stocks dropped to just 33%.
Even though the decade contained a prolonged
bull market, most smaller stocks recorded
a loss, not a gain.
Another way of measuring the size difference
is to calculate not how many stocks recorded gains
or beat Treasury bills (which yielded so little
that they returned almost nothing), but instead
how many outdid meaningful benchmarks.
One such benchmark is the Morningstar US
Government and Corporate Bond Index;
another is the previously mentioned Morningstar
US Market Index. That test's results appear
in EXHIBIT 3.
Once again, the disparity between the size
groups is apparent. A randomly chosen company
from the biggest 1,000 list was more than
twice as likely to survive the period and surpass
the bond index than a stock picked from
the next 4,000. The precept that most stocks
disappoint applied much more to secondary
stocks than to larger organizations.
That said, even the biggest 1,000's results
weren't sterling. Although equities thrashed bonds
for the decade, by the whopping cumulative
margin of 267% to 49%, only about half of
the biggest 1,000 stocks beat the bond index.
Against the stock index, their winning percentage
plummeted to just 20%. In other words,
four out of five large U.S. stocks trailed their
own performance benchmark.
Shrinking the list from the biggest 1,000 to
the Nifty Fifty doesn't greatly change that
EXHIBIT 1
The Decade's Performance Only 42% of
stocks finished with gains.
5,000 Largest U.S. Stocks, January 2011 to
December 2020.
50%
42
36
22
30
40
20
10
Up
Down
Gone
Source: Morningstar Direct. Data as of 12/31/2020.

https://www.morningstar.com/authors/208/john-rekenthaler https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447 https://www.morningstar.com/funds/xnas/vfinx/quote https://www.morningstar.com/stocks/xnas/amzn/quote https://www.morningstar.com/stocks/xnas/msft/quote https://www.morningstar.com/funds/xnas/vfinx/quote https://www.morningstar.com/stocks/xnys/xom/quote https://insight.bailliegifford.com/data/article/details/8767?article=the-pursuit-of-extreme-returns https://www.morningstar.com/articles/801806/most-stocks-stink https://www.morningstar.com/articles/801806/most-stocks-stink

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