Hendrik Bessembinder: ‘Do Stocks Outperform Treasury Bills?’

Episode Summary

Executive Summary: Morningstar’s Jeff Batak and Christine Benz interview Hank Bessembinder about his research showing that most individual stocks fail to beat Treasury bills over their lifetimes, while a tiny minority create most of the market’s wealth. He explains that this reflects positive skewness in long-term compounded returns, with important implications for diversification, active stock picking, rebalancing, IPOs, and how investors measure risk and performance.

Main Topics: Why the paper was written (Priority: 5/5): Bessembinder says the study began accidentally when he noticed negative average log returns in a large stock sample, prompting him to test whether many stocks actually destroy wealth over time. Most stocks underperform cash over their lifetimes (Priority: 5/5): The core finding is that a majority of stocks fail to outperform Treasury bills over their full public-market lives, despite stocks as an asset class outperforming cash on average. Positive skewness and market concentration (Priority: 5/5): Bessembinder argues the key mechanism is positive skewness: a small number of huge winners offset many losers, driving the average stock-market return. Characteristics of winners and losers (Priority: 4/5): Many underperformers delist or go bankrupt, while the biggest winners tend to show strong fundamental growth in assets, sales, cash, and especially net income; small stocks show more skewness than large stocks. Implications for active vs passive investing (Priority: 4/5): The findings support both diversified indexing and selective stock picking, depending on an investor’s skill, tolerance for concentration, and ability to endure drawdowns. Risk measurement and portfolio construction (Priority: 4/5): Bessembinder argues long-horizon returns are not normally distributed, so traditional tools like standard deviation, Sharpe ratio, alpha, and mean-variance optimization may be less informative than commonly assumed. Broader implications: IPOs, compensation, and global markets (Priority: 3/5): He says the pattern appears internationally as well, may affect how investors view IPOs and stock compensation, and suggests public markets resemble venture capital in their skewed payoff structure.

Key Arguments: Most individual stocks fail to beat Treasury bills over their lifetimes, but the stock market as a whole still earns a higher average return because a very small set of stocks creates outsized gains. The apparent contradiction between average stock-market returns and most stocks’ poor lifetime outcomes is explained by positive skewness in compounded returns. The phenomenon is strongest among small-cap stocks because they are more volatile, and compounding magnifies skewness over long horizons. Many losers disappear through delisting, bankruptcy, mergers, or takeovers; CRSP attempts to capture final delisting values, including control premia. The biggest winners are not easily identified ex ante using publicly available information; in hindsight they tend to be firms with strong underlying growth rather than simply high market-to-book ratios. Some large companies can become major winners late in life, showing that home-run returns are not confined to tiny start-ups. Diversification lowers standard risk but also reduces exposure to skewness; concentrated portfolios increase the chance of a home-run outcome but also the chance of underperformance. Long-horizon performance metrics rooted in normal-distribution assumptions may be misleading for actual investor experience. The same broad pattern appears in international stock markets, suggesting the finding is not unique to the U.S. The research has implications for IPOs, stock-based compensation, and possibly whether lockups or concentrated vehicles are better suited for active long-term stock picking.

Data Points: Original sample period: 1926-2016 - Time span covered by the original U.S. study discussed in the interview. Total stocks in original study: about 26,000 - Approximate number of publicly listed U.S. stocks in the CRSP-based sample. Stocks beating Treasury bills: about 43% - Share of stocks that outperformed Treasury bills over their public-market lifetimes. Stocks failing to beat Treasury bills: about 57% - Share of stocks that underperformed Treasury bills over their lifetimes. Wealth-creation concentration: about 4% of stocks - Approximate share of stocks responsible for essentially all net wealth creation in the sample. Still listed by end of 2016: a little over 4,000 stocks - Number of original-study stocks that remained listed in the database at the end of the sample period. Delistings for negative reasons: over 9,000 stocks - Stocks removed for poor performance, income-related issues, or share-price rule violations. Average listing duration: about 8-9 years - Typical time a stock remained in the database. Single-stock strategy beating Treasury bills: about 25% - In a 90-year simulation that picked one stock at random each month, the strategy beat Treasury bills only around one in four times. Single-stock strategy beating the overall market: about 4% - In the same simulation, the single-stock strategy beat the cap-weighted market only about 4% of the time. Largest decile beating Treasury bills over next decade: a little over 70% - Among the largest 10% of stocks by market cap at the start of a decade, more than 70% beat Treasury bills over the following decade. Global study scope: over 40 countries and about 65,000 stocks - International follow-up study showing the same broad pattern outside the United States.

Pivotal Quotes: "most of the individual outcomes will be less than the average outcome" — Hank Bessembinder: Explanation of positive skewness in stock returns and why most stocks underperform while a few winners dominate. "the stock market really maybe has more in common with venture capital than we may have realized" — Hank Bessembinder: Comparison of public-equity payoff distributions to venture capital’s few-big-winners structure. "the majority of stocks underperform Treasury bills and that a very small percentage of stocks are ultimately responsible for the value creation in the markets" — Hank Bessembinder: Summary of the cross-country evidence from the international stock study.

Implications: Investors should expect extreme skewness in long-term stock outcomes: diversification remains vital, but concentrated skill-based stock picking can still pay off for a minority. Traditional risk metrics may miss the true distribution, and the same pattern likely persists globally.