I want to draw your attention to a fantastic post at Morningstar by John Rekenthaler on the relationship between the performance of individual stocks and the performance of the stock market indices. Here’s a snippet:
The larger companies were far more reliable than their smaller rivals. 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.
It’s full of interesting graphs. Although I recommend reading the whole thing, if you’re not willing to do that I’ll summarize his findings:
- The majority of stocks either decline or cease to exist over time.
- The stocks that go up over time tend to be those of large companies.
- Almost all of the stock indices performance is produced by a very small number of stocks.
Bessembinder’s boldest claim was that 4% of the U.S. stock market’s companies accounted for its entire gains. Such math does not hold during bull markets. (If an index appreciated by 1% for the year, a single stock could well be said to have accounted for all its gains. If the index appreciated by 30%, then many, many stocks will be required for the task.) However, as shown by the following table, which measures the performance con
I look forward eagerly to his next post on the implications of it all. I would add that the small companies tend to employ more people relative to their total earnings than large ones do and that large companies are more likely to be subsidized in one fashion or another. Since so much of the increase in income and wealth inequality is derived from stock market performance, that means that government policy is actually subsidizing reduced unemployment and inequality.
To coin a phrase, I didn’t know whether to laugh or cry.
So Mr Rekenthaler has stumbled upon the fact, taught in any business school I know of, that large companies are more stable and can withstand turmoil better than small companies. This is true for a number of reasons, including the one you cited in the last paragraph. And don’t discount that the death rate of smaller companies includes merged or acquired companies, because some of the best of them are attractive. The statistic becomes more hazy.
I don’t really know what he is attempting to illustrate with his observation that a relatively few companies account for the gains in an index. That is well known. Further, performance should probably be measured over various time frames. However, from an investment point of view, one doesn’t know which ones will be the winners before the choices are made. This is the root concept for portfolio theory and diversification, also taught in any business school I know of.
Otherwise, if it was that easy, people would just get up in the morning and say, “gee, I think I’ll go out and buy nothing but winners today. Who knows, maybe all winners tomorrow as well.” Hmmm. Sounds like a good idea, eh?