Streetwise for Sunday, May 21, 2017
Grist is grain that has been separated from its chaff in preparation for grinding. A recent article detailing an academic study of stock prices is providing the grist for being ground up in this week’s column.
A recent study by Hendrik Bessembinder, a finance professor at Arizona State University, begins with the theme that that while investing in the overall stock market makes sense, the obstacles facing individual stock pickers are formidable.
According to Bessembinder, individual stocks resemble lottery tickets. A very small percentage of stocks have done splendidly, but when gains and losses are tallied up over their lifetimes, most stocks have earned zero.
What’s more, Bessembinder claims that 58 percent of individual stocks since 1926 have failed to outperform one-month Treasury bills over their lifetimes. That is a low bar given the returns on one-month Treasury bills.
Bessembinder states that only four percent of the stocks in the entire market – headed by Exxon Mobil and followed by Apple, General Electric, Microsoft and IBM – accounted for all the net market returns from 1926 through 2015. By contrast, the most common single result for an individual stock over that period was a return of a nearly negative 100 percent – almost a total loss.
Using a database developed at the University of Chicago’s Center for Research in Security Prices (CRSP), Professor Bessembinder surveyed virtually every stock listed on the broad American market from July 1926 through December 2015.
He compared their returns with those of one-month Treasury bills over periods as short as one month and for the entire time. Viewed as single units, Professor Bessembinder reported that the typical stock does not outperform Treasury bills.
Yet the overall stock market certainly does exceed the performance of bonds and Treasury bills by very wide margins. Data posted by Aswath Damodaran, a New York University finance professor, whose work I admire, indicated that since 1928, stocks returned about 9.5 percent, annualized, compared with only 4.9 percent for 10-year Treasury bonds and 3.5 percent for three-month Treasury bills.
There is no debating that statistically the stock market has a positive skew – meaning, a relatively small number of outliers like Exxon or Apple have such great returns that they pull up the average return. Put another way, the average return is higher than the median or typical return. However, this does not suggest that stock selection cannot be successful.
“People who pick the right stocks can have lottery-like returns,” Bessembinder said. “They may want to take that risk and do so.”
However, he does strongly imply that those individuals picking stocks are basically heading for failure.
I am not going to argue with Bessembinder’s findings or his interpretation of those findings. I also use the CRSP data base among others. Where I take issue, is the generalization that the markets are so efficient, meaning that all available information has already been incorporated into the price of a stock and therefore it is not possible to exceed an index such as the S&P 500.
My own research, including that being incorporated into my doctoral dissertation, shows quite succinctly and with statistical significance that the utilization of such key factors as increasing dividends and intrinsic value, i.e., discounted cash flow modeling, can enable the construction of portfolios capable of outperforming the S&P 500 index over a 3, 5 and 10-year timeframe.
What is even more galling to me is the suggestion that the way to invest is via index based mutual funds, often of the exchange traded fund (ETF) variety. Not only can you not beat the market if you buy the market, it is an abdication of your investment responsibilities. And there is the issue of fees.
Some advice. While they are not the easiest reading, books by Aswath Damodaran are excellent and will provide you with solid investment knowledge and direction. An easier read, and should be mandatory for any investor, is Benjamin Graham’s, “The Intelligent Investor.”
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.