Streetwise for Sunday, April 28, 2019
“Get your facts first, then you can distort them as you please.” – Mark Twain
Sometime back I discussed a paper written by Hendrik Bessembinder, a finance professor at Arizona State University, which I do not agree with, but appears to be particularly applicable to what many believe to be today’s investing climate.
The paper started off with the theme that that while investing in equities 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 well. Moreover, when all the gains and losses are tallied up, you have a zero return.
Bessembinder also claimed that 58 percent of all 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.
Look at the problem from a slightly different perspective. Most people have never had the pleasure (or the pain as the case may be) of creating, building and growing a company. If you have, you know it is hard work and the risks are high.
Approximately 90 percent of all startups fail within the first year. Therefore, finding a company that will continue to grow and create value over a 20-year plus time horizon is a difficult prospect.
Similarly, being able to identify what Bessembinder wrote are the four percent of all stocks that will generate long-term gains is extraordinarily difficult.
You must develop a process that gives you the best odds finding long-term investments whose earnings grow and compound. Wait a minute! Does that not sound a bit like the, “10-years of increasing dividends plus intrinsic value,” approach I speak of so often.
Most any stock will at one time, or another chalk up a relatively weak performance. Such is the nature of investing. However, if you are patient the good years will far outweigh the few weak ones.
I would agree that there are two major ways to outperform the market. You can take advantage of short-term price dislocation versus a company’s value or use long-term compounding to achieve market outperformance.
Both require strong behavioral attributes, tremendous patience and a considerable knowledge of your investments. At the same time, carefully selected equity portfolios can exceed the performance of Treasury securities by a wide margin.
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 annually, compared with only 4.9 percent for 10-year Treasury notes 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 Apple have such great returns that they pull up the average.
I also take issue with Bessembinder generalization that the equity markets are strongly efficient, meaning that all available information has already been incorporated into share prices and therefore it is not possible to generate a return in excess the S&P 500 index. Most academic studies side with me.
My own research, including that incorporated into my doctoral dissertation, shows quite succinctly and with statistical significance that the utilization of such key factors as dividend increases 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 period of 3 to 5 years.
What is even more galling, is the suggestion that the only way to invest is via index or exchange traded funds (ETFs). Not only can you not beat the market if you buy the market, it is in my opinion an abdication of your investment responsibilities.
Here is 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 ww.RuddReport.com.