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Statistics show that very few stocks make all the gains – how do we find them?

Hendrik Bessembinder from Arizona State University came out with a thought-provoking paper (here) about stock returns. The main findings, that got the financial blogosphere spinning:Just 1.3% of the world’s public companies account for all the market gains during the past three decades!

1.3 % is not a lot. Not matter how you slice and dice it

I even tried 3D

The fact that return distributions in public equities in the long run are very unevenly distributed becomes apparent with some more numbers from the paper:

  • Just five companies — Apple Inc., Microsoft Corp., Amazon.Com Inc., Alphabet Inc. (Google) and Exxon Mobil Corp. — accounted for 8.3% of global net wealth creation while accounting for just 0.008% of the total sample set of 62,000 publicly traded companies
  • Less than half of the stocks in the study – 23,905 – had cumulative positive returns
  • 37,195, or 60.9%, were net money losers

What can investors learn from that? First, you can have VC-like returns and return distributions with public equities – just wait 30 years. Apart from that, two groups where forming around that paper:

A: “This shows, what a ridiculous attempt stock picking is. No one will be able to beat these odds. Just buy market cap index funds to make sure you have the winners and get over the fact that you must buy all the losers as well to get the market return.”

B: “This shows how rewarding stock picking can be. If you can find only 1 or 2 of these stocks that go up by 10,000 percent or more – you will be rich. Hold on to your winners and cut your losers fast – most of them will never make you money.”

The middle ground, where we at Quant IP feel comfortable would rather sound like that: “Such distributions are expected. It´s called capitalism! Only very a few companies can withstand the never-ending battle with old and new competitors, survive business and innovation cycles and keep on creating value for shareholders. It´s very hard to find those a few companies and stick to their stocks for 30 years. But you can at least try to filter companies that most likely will not make it.”

When back testing portfolios based on our Quant IP Innovation Score, we found that it worked mainly by filtering out non-innovative companies. Sound investing means avoiding losers, not trying to pick those 1.3 percent super-stocks. Sorting out companies that have very little chance of surviving in the long run because they are not good at innovating will give you an edge without having to risk all your money on a few names.