Buy The Haystack

As a financial advisor, I’m always on the lookout for insightful data that can enhance the guidance I provide to my clients. Recently, I came across a captivating academic paper by Hendrik Bessembinder, Ph.D., a finance professor at Arizona State University. His study, titled “Which U.S. Stocks Generated the Highest Long-Term Returns?” ¹ offers valuable insights into the long-term performance of individual stocks and reinforces some key principles of investing.

Key Findings

Bessembinder’s research analyzed 29,078 publicly-listed common stocks in the University of Chicago’s Center for Research In Security Prices (CRSP) database from December 1925 to December 2023.  The findings are both striking and instructive:

1. Majority of stocks underperform: Surprisingly, 51.6% of the stocks studied had negative cumulative returns over their lifetimes. This means that more than half of all stocks actually lost money for investors in the long run.
2. Exceptional performers: Despite the poor performance of many stocks, some delivered truly remarkable returns. Seventeen stocks achieved cumulative returns exceeding five million percent, which translates to $50,000 or more for every dollar initially invested.
3. Top performer: The highest cumulative return was an astounding 265 million percent, earned by long-term investors in Altria Group. This means that a $1 investment would have grown to $2.65 million over the study period.
4. Modest annualized returns: Interestingly, the annualized compound returns of these top performers were relatively modest, averaging 13.47% across the top seventeen stocks. This highlights the power of compounding over long periods.
5. Highest annualized return: For stocks with at least 20 years of return data, Nvidia shareholders enjoyed the highest annualized compound return at 33.38%.

Implications for Investors

These findings have several important implications for investors:

1. Diversification is crucial: Given that the majority of stocks underperform, it’s clear that picking individual winners is extremely difficult. This underscores the importance of diversification to capture the outsized returns of the few top performers.  As John Bogle, the founder of Vanguard, famously proclaimed, “Don’t look for the needle.  Buy the haystack!”
2. Index funds have an advantage: The research helps explain why index funds are so hard to beat. By owning the entire market, they ensure exposure to the small number of stocks that drive overall market returns.
3. Time in the market matters: The relatively modest annualized returns of even the top-performing stocks highlight the importance of long-term investing. The power of compounding over decades – often referred to as the “eighth wonder of the world” – is what leads to truly exceptional returns.
4. Skewness in returns: The study reinforces the concept of positive skewness in stock market returns. A small number of big winners more than make up for the large number of underperforming stocks.
5. Challenges for active management: The concentration of returns in a small number of stocks explains why poorly diversified active strategies often underperform market averages.

Historical Context

Bessembinder’s latest paper builds on his previous groundbreaking research, which found that just 4% of stocks accounted for all of the wealth creation in the U.S. stock market since 1926.² This new study provides even more granular detail on the specific stocks that have generated the highest long-term returns.

Conclusion

Of course, we must always remember that past performance doesn’t guarantee future results. However, this research provides valuable insights into the nature of stock market returns and reinforces some fundamental principles of investing:

1. Diversification is essential to capture the few big winners that drive overall market returns.
2. Long-term investing allows the power of compounding to work its magic.
3. Index investing provides a reliable way to participate in the market’s overall wealth creation.

While it’s tempting to try to pick the next Altria or Nvidia, the data clearly shows that such outsized winners are rare. Instead, a well-diversified, long-term approach remains the most reliable path to building wealth in the stock market. By applying academically sound, evidence-based insights, such as those offered by Bessembinder, investors can maximize their chances for long-term financial success.

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¹ _{“Which U.S. Stocks Generated the Highest Long-Term Returns?” Journal of Performance Measurement, Fall 2024.}

² _{“Do Stocks Outperform Treasury Bills?”, Journal of Financial Economics, September 2018.} 

_{Abramson Financial Planning, LLC does not warrant the accuracy of the materials provided herein. Although the information provided is from sources which we believe to be reliable, we do not guarantee the accuracy or timeliness of any information for any particular purpose. This information is for information purposes and does not constitute a recommendation for the purchase or sale of securities. Individual investment decisions should be made based on each investor’s financial condition, suitability, and risk tolerance. Investments may be volatile and can involve the loss of principal. Past performance is no guarantee of future returns. Abramson Financial Planning’s employees may trade for their own accounts in any of the securities of issuers mentioned herein or in related investments. Abramson Financial Planning does not undertake to provide clients with tax, legal, or accounting advice, and clients are admonished to consult their own attorneys and accountants for determining the tax, legal, and accounting consequences of investments made on their behalf.}