Hendrik Bessembinder has contributed to our understanding of the distribution of returns and the benefits of diversification when investing in U.S. public equities. For example, in his 2021 study “Wealth Creation in the US Public Stock Markets 1926-2019,” he analyzed the long-run stock market outcomes in terms of the increases or decreases (relative to a T-bills benchmark) in shareholder wealth creation (SWC), considering the full history of both net cash distributions and capital appreciation. His data sampled included all the 26,168 firms with publicly traded U.S. common stock since 1926. In calculating the change in net worth, he explicitly accounted for new share issuances, share repurchases and the fact that dividends are not (in aggregate) reinvested in the stock market—share repurchases and dividends reduce market capitalization but do not similarly decrease calculated shareholder wealth creation. Among his key findings were:
• A majority of stocks led to reduced rather than increased shareholder wealth.
• Aggregate shareholder wealth creation has been concentrated in a relatively few high-performing stocks.
• The 86 top-performing stocks, less than one-third of 1% of the total, collectively accounted for more than half the wealth creation. And the 1,000 top-performing stocks, less than 4% of the total, accounted for all the wealth creation—the other 96% of stocks just matched the return of riskless one-month Treasury bills!
• The degree to which stock market wealth creation has been concentrated in a few top-performing firms has increased over time and was particularly strong during the most recent three years of the study, when five firms accounted for 22% of net wealth creation.
• The concentration of SWC is attributable to positive skewness in the distribution of long-run stock market outcomes. Since most individual outcomes in a positively skewed distribution are less than the average outcome, this implies that undiversified portfolios selected at random will underperform the overall market more often than not, reinforcing the prudence and desirability of low-cost, broadly diversified strategies.
New Research
In his July 2024 paper, “Which U.S. Stocks Generated the Highest Long-Term Returns?” Bessembinder analyzed the returns of the 29,078 publicly-listed common stocks contained in the CRSP database over the period 1926-2023. Following is a summary of his key findings:
• On average companies appeared in the CRSP data for only 11.6 years.
• The median lifespan was just 6.8 years.
• Only 31 stocks were present in the database over the full 98-year period.
• The majority (51.6%) had negative cumulative returns—most stocks destroyed value.
• The median outcome was a return of -7.41% per annum.
• The mean compound return outcome was strongly positive while the median outcome was negative results from the positive skewness in the distribution of compound stock returns.
• Even restricting the data to include those stocks that had at least five years of history (but not more than 20) resulted in the majority producing negative returns.
• Even among the 30 stocks with the highest cumulative compound returns the results were relatively modest—the median annualized return across the 30 stocks was 13.03%, while the mean was 13.05% and the largest was Altria Group’s 16.29%. How many investors would have guessed that one?
His findings led Besembinder to conclude: “While very high annualized returns are observed in the historical data over relatively short periods, such dramatic returns have historically not been sustained over long intervals.” He added: “The highest annualized returns attained by any stock are systematically lower among those stocks with longer lives.”
Investor Takeaways
While a large equity risk premium has been available to investors, a large majority of stocks have had negative risk premiums. This finding demonstrates just how great the uncompensated risk is that investors who buy individual stocks (or a small number of them) accept—risks that may be diversified away without reducing expected returns. Thus, the takeaway for any investor considering adopting an active strategy because they have a preference for positive skewness in the distribution of outcomes is that they are likely accepting lower returns in exchange for the positive skewness.
Since the historical record indicates that it is likely that the net wealth creation/destruction attributable to the overall stock market in the future will be concentrated in relatively few firms, and that active management is unlikely to benefit from that concentration, the winning strategy is to avoid active security selection and/or market timing.
Summarizing, investors make mistakes when they take idiosyncratic, diversifiable, uncompensated risks. They do so because they are overconfident of their skills; they overestimate the worth of their information; they confuse the familiar with the safe; they have the illusion of being in control; they don’t understand how many individual stocks are needed to effectively reduce diversifiable risks; and they don’t understand the difference between compensated and uncompensated risks (some risks are uncompensated because they are diversifiable). Another likely explanation for the lack of diversification from the field of behavioral finance is the aforementioned preference by many investors for positive skewness—they are willing to accept the high likelihood of underperformance in return for the small likelihood of owning the next Google. In other words, they like to buy lottery tickets.
If you have made any of these mistakes, you should do what all smart people do: Once they have learned that a behavior is a mistake, they correct their behavior.
Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing.