Stock Picking is a Risky Business

On Friday, April 9th, the U.S. stock market, as measured by the S&P 500 Index, hit another record high. It was the 20th time this year that a record high has been achieved. The U.S. stock market, using the broader market index of the Russell 3000 Index of 2,676 publicly traded stocks, is now worth a grand total of $44.5 trillion dollars. Just over half of the value of the U.S. stock market is found in just 84 stocks, all worth over $100 billion each. The top four (Apple, Microsoft, Amazon and Alphabet (Google)) are worth $7.4 trillion combined.[1]

While the shareholder wealth creation story in the U.S. is truly amazing, there is another side which seldom gets any attention: historically, most stock investments destroy shareholder wealth. Researcher Hendrik Bessembinder of Arizona State University looked at all 26,168 publicly traded U.S. common stocks issued between 1926 and 2019. He found that 58% of stocks actually reduced shareholder wealth when looking at the full history of cash distributions and capital appreciation. Further, he writes that “Aggregate shareholder wealth is concentrated in a relatively few high performing stocks.”[2] A 2017 study by the same author concludes: “When stated in terms of lifetime dollar wealth creation, the entire gain in the U.S. stock market since 1926 is attributable to the best-performing four percent of listed stocks.”[3]

Looking at data from 1980 to 2019, another study by Michael Cembalest of JP Morgan Asset Management, speaks of “creative destruction” where “many new businesses end up displacing incumbents who were at one time leaders themselves.” He states that since 1980, over 400 companies were removed from the S&P 500 Index due to “distress” (such as outright business failure or substantial decline in stock price). Further, “40% of all companies that were ever in the Russell 3000 Index experienced a “catastrophic stock price loss,” which is defined as a “70% decline in price from peak levels which is not recovered.” In contrast, only about 10% of all stocks since 1980 would be defined as “Mega-winners”: stocks that outperformed the Russell 3000 Index by 500% or more. These are often the stocks that drive broad market performance.[4]

What are the key lessons we can take away from these studies? First, and most obvious: stock investing is a risky business. The odds of discovering the next Mega-winner are decidedly not in your favor. Further, if you choose to own only a single stock, the Cembalest study determined that, since 1980 at least, you would have underperformed the Russell 3000 Index around two-thirds of the time.

Diversifying your stock investments across many names, countries and industries not only reduces the impact of individual “catastrophic stock price loss” but also increases the chance of owning the Mega-winners. Owning a diversified index fund that seeks to replicate the returns of a market index such as the S&P 500 gives you exposure to all of the high performing stocks which ultimately drive the broad market performance. You also own all the losers, but in a capitalization-weighted index, their impact is relatively small. In effect, you own the market and earn what the market gives you (fewer fees and expenses).

Second, does this mean we should never own concentrated portfolios of stocks, say 50 names or fewer?  No, because an actively managed portfolio could improve your odds of investment success over a market cycle. Professional money managers continually assess the relative risk and return potential for the stocks they own within the segment of the market they specialize in (strategies such as value or growth, large cap or small cap).

While no money manager gets it right every time, good managers may be able to avoid owning (or quickly sell) stock in companies with deteriorating fundamentals, while keeping (or adding to) positions in companies for which they have a high conviction. Further, some strategies will do well relative to other strategies over particular time periods, market or economic cycles, so diversifying across active managers can also be advantageous.

At Coyle Financial Counsel, we believe there is a place for both highly diversified, low cost index-like strategies as well as more concentrated, actively managed strategies. In the latter case, we perform detailed due diligence before hiring a manager to make sure we understand their investment process and philosophy, as well as past performance, experience and continuity of the investment management team. Once hired, we conduct continuing due diligence to ensure there are no significant deviations from their mandate or any key personnel changes.

One cannot hope to enjoy the potential rewards of investing without accepting the risk of loss. In utilizing both well-diversified and actively managed concentrated strategies, our goal, as always, is to help clients achieve their long-term financial goals by crafting an asset allocation suitable and structured to each client’s risk capacity and tolerance.



John serves as Chief Investment Officer for Coyle Financial Counsel and is responsible for overseeing the investment process. John’s prior experience includes managing institutional fixed-income portfolios for corporations, pension funds, non-profit organizations and foundations at several large, global asset managers. With more than 20 years of institutional investment experience, he is energized by helping individuals understand the role investing plays in meeting their long-term financial goals.
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All information is from sources deemed reliable, but no warranty is made to its accuracy or completeness.   This material is being provided for informational or educational purposes only, and does not take into account the investment objectives or financial situation of any client or prospective client.  The information is not intended as investment advice, and is not a recommendation to buy, sell, or invest in any particular investment or market segment.  Those seeking information regarding their particular investment needs should contact a financial professional.  Coyle, our employees, or our clients, may or may not be invested in any individual securities or market segments discussed in this material.  The opinions expressed were current as of the date of posting but are subject to change without notice due to market, political, or economic conditions. All investments involve risk, including loss of principal.  Past performance is not a guarantee of future results.

Copyright © 2021 Coyle Financial Counsel.  All rights reserved.

[1] Source:  Morningstar Direct

[2] “Do Stocks Outperform Treasury Bills?” by Hendrik Bessembinder, Arizona State University (2019)

[3] “Wealth Creation in the U.S. Public Stock Markets 1926 to 2019”, by Hendrik Bessembinder, Arizona State University (2017)

[4] “The Agony and the Ecstasy: The Risks and Rewards of a Concentrated Stock Position”, Michael Cembalest, J.P. Morgan Asset Management (2021)


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