TIP667: Why Most Stocks Will Lose You Money w/ Professor Hendrik Bessembinder

Episode Summary

Executive Summary: Professor Hendrik Bessenbinder explains that stock returns are extremely asymmetric: most stocks lose money or underperform T-bills, while a tiny fraction create nearly all long-run wealth. He argues this comes from compounding, limited downside, and unlimited upside, making stock picking both alluring and difficult. The discussion covers drawdowns, industry patterns, international evidence, and why indexing and active stock picking each retain a strong case.

Main Topics: Stock return skewness and wealth concentration (Priority: 5/5): Bessenbinder’s central finding is that stock returns are highly positively skewed: a small minority of companies account for most long-run gains, while most stocks underperform and many fail outright. Why most stocks underperform (Priority: 5/5): He explains that although the market’s average return is positive, the typical stock is not. A few huge winners lift the mean, which is why many individual stocks lose money over long horizons. Compounding, limited liability, and asymmetry (Priority: 5/5): The asymmetry of returns becomes more pronounced over time because losses are capped at -100% while upside is theoretically unlimited. Compounding magnifies this imbalance. Drawdowns among eventual winners (Priority: 4/5): Even the biggest winners endure severe declines along the way. This shows that long-term winners are often psychologically difficult to hold and can experience large interim losses. Industry and global patterns (Priority: 4/5): Technology stocks are prominent among famous winners, but not necessarily the most likely to become winners. The skewness pattern also appears internationally and may be even stronger outside the U.S. Active vs. passive investing debate (Priority: 4/5): Bessenbinder says the research supports both sides: indexing benefits from avoiding the many losers, while skilled stock pickers can still achieve extraordinary outcomes if they truly have comparative advantage. What characteristics matter in winners (Priority: 5/5): Among observable traits, rapid net income growth stands out as the best predictor of eventual winners, while valuation ratios such as P/E and P/B do not reliably forecast who will become a long-term outlier.

Key Arguments: The average stock return can be positive even if most stocks underperform, because a small number of extreme winners pull up the mean. Stock returns are fundamentally asymmetric: downside is limited to -100%, but upside is uncapped, so a few companies can create enormous wealth. The concentration of wealth creation is not just a U.S. phenomenon; similar skewness appears in global markets. Large drawdowns are normal even for eventual winners, so investors must expect volatility if they want to own potential outliers. Technology companies dominate public attention, but they are not necessarily the most likely to be top performers; some older, less glamorous industries can be more reliable long-term compounders. High net income growth is the clearest observed characteristic of eventual long-term winners, but it is difficult to predict in advance. Indexing is attractive because missing the small set of huge winners can devastate relative performance, yet active investing remains valuable if the investor truly has skill and edge. Valuation multiples are informative but did not show meaningful predictive power for identifying the stocks that eventually ended up in the right tail. Long-term return leadership often comes from companies with durable competitive moats and long time horizons, not necessarily from the most exciting or fastest-rising stocks. The economy needs active investors because they help price securities efficiently by buying undervalued assets and selling overvalued ones.

Data Points: Share of U.S. listed companies creating net shareholder wealth: ~4% - Since 1926, only about 4% of U.S. listed companies generated all net shareholder wealth creation. Stocks beating Treasury bills: About 4 out of 7 (roughly 57%) do not beat T-bills - Bessenbinder said the majority of stocks fail to outperform Treasury bills on a compounded-return basis. Sample period in original study: 1926–2016, later updated through 2020 and 2022 - The study followed CRSP data over nearly a century and was extended in later versions. Number of U.S. companies in one study: 25,000 companies - Referenced in the discussion of total wealth creation across the sample. Net wealth creation: $35 trillion - Aggregate wealth creation across the studied U.S. stock sample. Top 90 companies' share of wealth creation: Over 50% of $35 trillion - A tiny subset of companies accounted for more than half of total wealth creation. Top companies accounting for wealth creation: Top 1,092 companies - These represented the ~4% figure and accounted for all net wealth creation. Amazon drawdown: 90% - Example of a huge interim loss suffered by a major eventual winner. Average drawdown for top winners in the same decade: 33% - Among the top 100 wealth-creating stocks in a decade, average drawdown during that winning decade. Average drawdown in the prior decade before winner status: 52% - Those eventual winners experienced even deeper drawdowns before their breakout decade. 2017–2019 concentration example: 5 companies accounted for 22% of net wealth creation - Illustrates how concentrated recent market wealth creation has become. Long-term return of Altria: 16.2% CAGR; 265 million% total return - Top performer in the later study of highest long-term returns. Long-term return of Vulcan Materials: 14% CAGR; 39 million% total return - Second on the list of all-time performers. Time horizon where skewness becomes obvious: About a decade - Monthly and annual returns show fat tails, but decade-long compounding makes asymmetry much more visible. Historical wealth concentration outside the U.S.: Even stronger than in the U.S. - Global sample over 30+ years showed the same pattern, with stronger concentration outside America. NASDAQ listing pattern: Higher failure rates and more skewness than NYSE/AMEX - Different listing standards and younger/riskier firms helped explain greater skewness on NASDAQ.

Pivotal Quotes: "the average outcome is higher than most of the individual outcomes" — Hendrik Bessenbinder: Explaining positive skewness and why a few winners dominate stock returns "the single most trauma outcome is losing all your money" — Hendrik Bessenbinder: Describing the asymmetry of stock investing versus the large upside of rare winners "it’s not enough to be good, it’s not enough to be smart. You have to be better than your competitors" — Hendrik Bessenbinder: His advice to prospective stock pickers about comparative advantage

Implications: Investors should expect most stocks to disappoint and only a few to drive huge returns. Diversification protects against missing winners, but skilled active investing can still add value. The key for stock pickers is comparative advantage, patience, and tolerance for severe drawdowns.