Chris Forrest- Senior Partner and Principal Adviser
Sovereign Wealth Partners
A Strategies Conference 2018 report
Nick Griffin of Munro Partners prosecuted the case for global growth stocks in his presentation with the opening statement, “It’s not an equity market, it’s a market of stocks. There are very few remarkable companies.”
When we buy shares, we aren’t buying units in some opaque market, we are buying shares in real businesses which sell products and services with the intention of making a profit. As it turns out, not many are all that good at it.
The evidence in the presentation contained one key reference which caught our attention.
A study of the US market from 1926 to 2016 by Hendrik Bessembinder at Arizona State University came up with a number of interesting statistics. The question the paper sought to answer was “Do Stocks Outperform Treasury Bills?”
Many would think this question has been answered time and time again and Bessembinder concedes this, however, it is based on a broadly diversified stock market portfolio. In his paper he focusses instead on individual stocks on a buy and hold basis. The reference point used was the Centre for Research in Securities Prices (CRSP) monthly stock return database which contains all common stocks listed on the NYSE, American Stock and Nasdaq exchanges.
The findings lead to a number of conclusions, but first let’s have a look at some of the outcomes:
- Only 47.8% of all monthly common stock returns are larger than the one-month Treasury rate in the same month – furthermore, less than half of monthly CRSP common stock returns are positive;
- Just 42.6% of common stocks have a buy and hold return over their full lifetime (inclusive of reinvested dividends) that exceeds the return to holding one-month Treasury Bills over the matched horizon;
- More than half of CRSP common stocks deliver a negative lifetime return – the most observed outcome for individual stocks over their full lifetime is loss of 100%.
These are disconcerting outcomes and it’s also worth noting the median time that a stocks is listed on the database was just seven and half years.
We know, however, that the US market has grown significantly over the last 90 years with periods of boom and bust. We also know that quite a number of companies have grown to a significant size and many investors have benefited from investing in US shares. So let’s look at a few more statistics coming out of the study:
- 25,300 stocks in the database are collectively responsible for lifetime shareholder wealth creation of nearly US$35 trillion (as at December 2016);
- BUT, just five account for ten percent of the total wealth creation (Exxon, Apple, Microsoft, General Electric and IBM).
- The ninety top performing companies account for over half of the wealth creation;
- The 1,092 top performing companies (4% of the total) account for all of the net wealth creation.
That’s extraordinary and worth saying again – just 1,092 companies are responsible for all the wealth generated on US stock markets. The remaining 96% of companies failed to generate lifetime dollar gains that exceeded one-month Treasury bills.
Still, how can this be?
The outcomes above are based on a buy and hold basis. In reality, the index is not a buy and hold strategy. Failing companies fall out of the index and growing companies become part of the index. The stock market has survivorship bias and so success produces success over the very long term.
What can we conclude from this? A number of things which some may contest:
- Active management is hard but if you pick the right stocks and you’re patient, it can be done;
- Buying and holding direct stocks is not a guaranteed recipe for building wealth over the long term – some active management is required (even if it is the index’s own activity);
- Stocks are high risk but the returns are there to be had. That said, there are no guarantees. It pays to diversify.
What about Nick’s conclusions?
Pretty straightforward – one of his take outs from the paper supports his thesis and investment strategy and that is that companies which come into the index are typically growing at 15% per annum. Furthermore, 50% of companies don’t survive more than 20 years. So, the companies to target are lasting the longest and/or growing the fastest and you have one of two ways to access these companies: 1. Invest in an index investment BUT you capture everything that’s failing as well; and/or 2. Invest in an active strategy which you believe will be able to capture the growth over time.
Of course, your strategy isn’t a polarised decision of one or the other and a diversified strategy can be adopted.
Munro offered 3 more views to long term success:
- Go growth, go global;
- Structural change is the key to identifying the growth stocks of the future;
- Near term valuation multiples can lead you astray – they may appear high and mask the attractiveness of earnings growth;
- Be aware of survivorship bias.
Sovereign’s investment philosophy certainly captures growth as a component of equity investing. We are mindful, however, of investor’s aversion to loss and the needs they must meet and so we take a portfolio approach when combining selective messages from investment managers.
Hendrik Bessembinder’s paper can be found here.
For more, contact Sovereign Wealth Partners.