The Bessembinder Factor


If there’s one unsung hero of the personal financial world that needs a medal, I think it should be Hendrik Bessembinder.  “Hendrik who?” you’re probably wondering…

Hendrik Bessembinder, is a professor from Arizona State University that researches and studies long-term wealth creation of the stock market.  He studies the how part of how the stock market creates wealth for investors.

Last year (2020), Bessembinder published an update to his research on shareholder wealth creation, in a paper called Wealth Creation in the U.S. Public Stock Markets 1926 to 2019.  What he found was extremely interesting (at least to money nerds like me)…

Of the 26,168 firms that listed public equity during this period, 11,036 firms (42.17% of the total) created positive wealth for their shareholders, while 15,132 firms (57.83% of the total) reduced shareholder wealth.

You read that correctly — over half of stocks did not create wealth when compared to holding T-bills.  Even more interesting, he discovered that shareholder wealth created by stocks is highly concentrated in just a few firms: eighty-three firms (0.317% of total) account for half of all stock market wealth creation.

What’s more, this shareholder wealth creation has become even more concentrated in recent years — over the last 3 years 22.1% of shareholder wealth was created by just five companies.

Even though the financial media likes to tout the incredible wealth creating ability of the stock market, the lesson to take-away from this research is that most stocks are losers.

 

The Case For Holding Stocks

Interesting, right?  So why is it that over long periods of time holding a broad selection of the stock market (indexing) has done so well?  If most stocks are losers, wouldn’t it be a better strategy to just hold T-bills?

Well, no.  Most stocks may be losers compared to T-bills, but when holding a broad selection of stocks (like an index fund) the rare winners did so incredibly well that it more than made up for all the losers.

This exemplifies why mass diversification in the form of an index fund has worked over time – The index fund casts a very wide net, and most of it’s catch is, well, losers!  But in the process of casting that incredibly wide net, it also allows the index investor to inadvertently catch that incredible fish that far outperforms the rest of the catch in the net.

It’s like winning the lottery by purchasing A TON of lottery tickets, instead of trying to win with just one or two.

 

Which Stocks Were The Winners?

Inevitably after hearing about this study, everyone asks — What are the stocks that created all this shareholder wealth at rates exceeding T-bills?

Here’s the list from Bessembinder’s research:

to performers
(Click to Zoom Into Image)

I caution though, this list SHOULD NOT be considered a list of stocks to buy in order to outperform the market.  Inevitably this list of stocks includes former winners that are now past their prime — and unlikely to outperform in the future.

Companies like GE, XOM, and IBM are good examples of “old world” companies on the list.  They may once have been kings in the U.S. Economy in the past, but they’re unlikely to ever regain that status again.  Most of the wealth created by those companies was in the past.  They’ve since been replaced with “new world” companies like Amazon, Google (Alphabet), Facebook, and Microsoft.

That’s the problem with extremely long-spanning research like this.  It’s useful to help us understand how the stocks create wealth, but it does nothing to help us understand how a modern list of stocks outperforms the market (or even matches the market for that matter).

 

A New List Of Wealth Creators

After reading Bessembinder’s research, I was intrigued by the disparity of old companies past their prime, and new companies compounding at much quicker rates of return.  Like the S&P500, the list contains both kinds of companies.

This brought an important point front and center — It isn’t just how quickly a stock can compound, but also how long it can compound for.  When Warren Buffet talks about the length of a company’s runway, this is what he’s talking about — How long can that company compound at good rates of return.

If a stock compounds very quickly for a few years and then burns out, it obviously won’t be on the list of mega wealth creators.  It stands to reason that only looking at top performers over short timespans leads to ‘market hype’ and ‘flash in the pan’ type stocks (think AOL) that don’t last.

What I really wanted to see was a list of wealth creating companies newer than 93 years old, and older than 10-15 years.  In other words, stocks that had managed to create great shareholder wealth in my lifetime but not so young that market hype was a deciding factor.

After some “google-research” I found this 30-year table created by CompoundAdvisors:

top performers 30 years

Notice anything different?  Immediately you can see these tables are completely different.  Mostly gone are the “old world” companies.  The list is now filled with top performing tech companies, or industries that have seen improving economics over the last 30 years (railroads for example).

Rare are the stocks the stocks that span both lists — Altria Group would be one example.  Not only has it been able to compound for a very very long time, but also has been able to do so at good rates of return in modern times.

Other big surprises to me are retailers like BestBuy and Ross Stores that have even outperformed tech stalwarts like Apple and Microsoft.  Amazing!

 

Lessons Learned

Inevitably after reading research like this, a number of lessons learned stand-out.  First and foremost, is how hard picking stocks is.  If so much of shareholder wealth creation is clustered around just a few rare stocks, this means the job of the stock picker is extremely difficult.

Outperformance is quite rare.  If you’re going to buy individual stocks, either know how to pick one of these incredible winners OR know how to avoid picking the losers.  Otherwise, don’t bother — just pick an index fund.  Casting a wide net with an index fund is OK as long as it allows us to catch hold of those mega-fish that eventually show up — the Apple’s and Amazon’s of this world.

Secondly, survivorship bias plays a big part in the results of this research.  Inevitably there were some very good performing stocks that did not ‘survive’ during the two time periods sighted in this post.  Some (like AOL) may have risen and fallen in a span of less than 30 years.  Other good performers (like Tableau), may have been bought-up by much larger companies and thus not ‘survived’ long enough to reach one of these lists.

Clearly longevity matters when compounding, but surviving for a long time has become much more difficult due to the shrinking life span of the average S&P 500 company.  According to research by Innosight, the average lifespan of an S&P 500 company has shrunk to a mere 18 years.

Third, I’d like to point out that growth rates aren’t everything.  Inevitably readers will take a look at the top stocks on these lists and surmise that growth was the most important factor, but this is a false deduction.  Growth played an important part of reaching the top of these wealth creation lists, but it wasn’t everything.  For many stocks on these lists, such as Kansas City Southern (KSU), Pool Corp (POOL), or Altria (MO), revenue growth was never a major strength.  Many saw annual revenue growth rates less than 10%, yet still managed to reach the top-performers lists.

On the surface this would seem like a recipe for underperformance, but over a long enough time period these “slow-growth monsters” really do shine.

And that’s really what most investors are looking for — consistently good performance over long periods of time.  Most of us have little need to own the best stock in the S&P 500, or to have the fastest growing portfolio compared to our peers.

While this research points at the lottery-like returns of the stock market, it’s only when we embrace the opposite path (diversification coupled with slow and steady growth) do we begin to see consistent returns over time.

It’s an important lesson that many new investors currently gambling on bitcoin or Gamestop really need to embrace.  Good luck out there!

 

[Image Credit: Flickr]

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18 thoughts on “The Bessembinder Factor

  • March 29, 2021 at 5:15 AM
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    I like this post a lot. The research behind it s very interesting. However don’t you think that Professor Bessembinder’s failure to include dividend will skews the results significantly? As haven’t divideds been more than 50% of total shareholder return over the past 100 years?

    Hope you are doing well out there.

    -Mike H

    Reply
    • March 29, 2021 at 12:47 PM
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      It’s a little bit tricky — Dividends were part of his shareholder wealth creation calculation, but they were not reinvested into the company stock. Instead, they were reinvested into T-bills. It gives dividends something of a “neutral” bias, I think. This could be seen as either a good thing or a bad thing.

      Dividends definitely played a bigger role in company performance in the past. That’s not really the case today however. Most of the “modern” performers pay pretty pitiful dividends, and that in fact plays a big part in their outperformance role.

      Reply
  • March 29, 2021 at 5:35 AM
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    Are you worried about the index funds heavy tilt on tech? May be I didn’t quite read between the lines. When you say diversification along with slow and steady … Is key for growth, did you imply a balanced allocation – not just between binds and stocks but also market segments? Any suggestions on the ideal splits there? Thanks for the lovely post.

    Reply
    • March 29, 2021 at 12:56 PM
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      In general, I’m not concerned about the number of tech firms now included in the S&P 500. Technology is where a lot of new value is being created. What concerns me is the excessive valuations that are happening right now. These seem likely to decline in future years. PE expansion can only go so far before it comes back to reality.

      Because tech firms make up such a large portion of indexes, those indexes may be set up for big declines if the market ever corrects. When or if that’s going to happen is anyone’s guess.

      Tech has done very well in the current decade, it becomes very hard to predict what will do well in future decades.

      Reply
  • March 29, 2021 at 8:31 AM
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    That’s interesting that the companies in the two tables are so different. I’m not sure I’d put down MO in the list though, given less and less people smoke nowadays.

    Reply
    • March 29, 2021 at 12:57 PM
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      I didn’t choose which stocks to put in the list. These lists are based upon performance only.

      Reply
  • March 29, 2021 at 8:42 AM
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    Great article and comments. People can definitely learn from this one. I forwarded to my kids 🙂
    Thanks!

    Reply
  • March 29, 2021 at 8:56 AM
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    This is really interesting, Mr. Tako! Once you found the CompoundAdvisors list, did you notice that a lot of what you hold was on it?

    Reply
    • March 29, 2021 at 12:58 PM
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      Surprisingly I do hold one of those stocks. Guess I got lucky!

      Reply
  • March 29, 2021 at 2:43 PM
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    One of the reasons I let Personal Capital invest part of my portfolio is that they use an equal weight strategy over a large number of sectors, so technology doesn’t hold any more weight than utilities or consumer goods or anything else. And even within the sectors they don’t use cap weighting to skew the investments to the FANG type stocks over smaller companies. I know that may have its own draw backs but I think it helps off set the rest of my investments which are in cap weighted index funds.

    Reply
  • March 29, 2021 at 4:25 PM
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    You’re right, personal finance nerds like me owe a lot to this research. I haven’t picked individual stocks in over a decade, I want to say. Passive investing has worked pretty well so far and hopefully it continues to do so.

    Individual stock picking can be fun but it’s recommended to keep that to the minority!

    Reply
  • March 29, 2021 at 9:32 PM
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    This is exactly why I’m sticking with the Bogleheads for the foreseeable future.

    I certainly may pick some individual stocks to hold long term, but it’ll be a small small percentage of my holdings.

    Reply
  • March 29, 2021 at 11:39 PM
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    I think that if you choose the dividend aristocrats and DRIP you would be very well. I wanna income from dividends and go with ETF’s like VOO doesn’t meet my goals.
    So i think there is a lot of ways to achieve our goals in the financial markets

    Reply
  • March 30, 2021 at 6:30 AM
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    yeah, picking the winners would have been luck when they IPO’d. Probably better to avoid too many losers, take small bets on single stocks, and then rather for the most part bet that equities will compound faster than other asset classes (ie Index vs single stock). Anyway, that’s what the risk-averse side of me says. Once FI you can do whatever, moonshot bets, speculate, higher potential growth stocks etc, but only with whatever cash is above your FI level.

    Thanks for the interesting research, fascinating about the railroads. Is the US one of the few countries with private rail?

    Reply
  • March 30, 2021 at 9:18 AM
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    Love this table.

    The thing is, if you pick one Walmart and hold it for decades the rest of your portfolio really doesn’t matter if you weight the holding appropriately and don’t sell. Even if you purchased Walmart decades ago when the PE was extremely high, you would have done extremely well as an investor.

    The key, in my opinion, is to find the long term compounding business and hold. They are hard to identify and even harder to hold. However, that is really how to find outperformance.

    Consider this, shareholders of Amazon suffered losses greater that 90% after the tech bubble. People who held on were rewarded. Not easy to wait 8 long years though to make back your money.

    Reply
  • March 31, 2021 at 5:10 AM
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    Didn’t he 1-month Treasury only come into existence in the early-1960s? How does he extrapolate all the way back to 1926?

    Reply
  • April 11, 2021 at 9:47 AM
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    Tako, I enjoyed this spin on the “why” for index funds vs individual stocks. It reveals some harder numbers behind the theory. As well as I understand how index funds work and can outperform many (most?) stock pickers, I don’t think I would have guessed just how few companies are really responsible for keeping indexers afloat. That’s impressive concentration.

    I wonder just how different this list would be for other countries—at least in the context of what sectors are outperforming with the more “modern” list you have. The US seems so tech heavy, though I don’t think that’s a surprise.

    I think Mr. Bessembinder would be happy to see his research used in this way. 🙂

    Reply

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