Home  >  articles  >  investor education  >  some thoughts about stock picking

Some Thoughts about Stock Picking


Each of us has a pet hate; something that annoys us each time we experience another tiresome example. In the world of finance, the thing that gets to me are those confident, brash and vociferous market commentators who deliver definitive comments in a financial world that is anything but certain.

A few of these commentators have widespread following. That their message is often wrong doesn’t seem to matter. It’s their confident manner that draws in disciples. And that scares me because their receptive audience takes blind direction from them.

I prefer my information to be delivered in the form of facts and research rather than by someone who shoots from the hip. So, in keeping with that, I’ve based this month’s article on some great research from Dr. Hendrik Bessembinder, a Professor of Finance at Arizona State University. I’ll be interpreting and applying Bessembinder’s findings in a practical way, which I hope assists you to make better informed decisions regarding stock selection and portfolio construction.

So, let’s get started.


Bessembinder’s Famous Study

Bessembinder’s best known study, titled Shareholder Wealth Enhancement, 1926 to 2022, is certainly an eye-opener. It relates specifically to U.S. stocks but he has since acknowledged that his findings can be applied world-wide (he’s studied other countries as well).

Bessembinder looked at how the US share market has generated wealth for investors. He defines shareholder wealth creation (SWC) as that dollar amount by which ownership of shares has exceeded the return otherwise achieved if all capital had been invested in one-month Treasury bills. His results are an absolute eye-opener.

Bessembinder found that a mere 3.4 percent of the 28,114 listed stocks available for investment between 1926 and 2022 accounted for all of the $55.1 trillion of SWC delivered over that 96-year period. It meant that if you’d owned all of the other 96.6 percent of stocks, to the exclusion of any of the 3.4 percent of high performers, then you would have done no better, after almost a century of investing, than had you put the whole lot into what is effectively cash.

In this light consider Warren Buffett’s Berkshire Hathaway. As at 31 March this year Berkshire held $305.5 billion in short-dated Treasuries. People have questioned why Buffett is holding more than a quarter of the company’s assets in T-bills. Amazingly it’s more than the Federal Reserve presently holds. Bessembinder’s study delivers a fresh perspective on Berkshire’s stance. Buffett stated at the recent AGM in May that attractive investment opportunities have been thin on the ground recently. In that light T-bills seem to be a sensible place for Berkshire to park its gushing cash flows until opportunity arrives.

So, how can we incorporate Bessembinder’s research into the process of stock selection? That depends on whether you are an optimist or a pessimist. An optimist might call it great news. Just picking the big winners will deliver significant outperformance. While a pessimist (some might say realist) is more likely to consider it too hard a process to identify such a small target, and to instead resign themselves to investing in the broad index. Both arguments have merit. But it does demand a realistic assessment of your ability as a stock picker in order to make the call. Just being competent at stock picking doesn’t cut it. To win at this game you need to be exceptional.

Bessembinder’s findings also help to explain the significant variations observed between the portfolio returns of investors both professional and amateur. The inclusion of just one exceptional stock in an otherwise run-of-the-mill portfolio can juice returns and elevate it above the benchmark return.

Copious research from the likes of S&P Indices, John Bogle, Eugene Fama and Kenneth French (to name just a few) has demonstrated that the principal determinant in portfolio manager’s returns is luck. Holding a ten-bagger in a portfolio can boil down to luck. Of course, fund managers and amateur investors alike, who do achieve an above-benchmark return in any given year, will deny that luck played a part. But self-interest and self-promotion can be powerful shapers of belief. I’m not saying that skill at stock picking doesn’t exist. But it is rare; rarer than most people believe. So don’t beat yourself up if your brother-in-law loaded up on Nvidia during Covid when it was selling for just ten bucks a share. Chances are he was just lucky.

The reality is that, for the average punter, who possesses no effective method for identifying potential outperformers, stock picking is like playing a game of cards with the following rules:

  • There are 300 cards in the deck, each card representing a company in the ASX 300.
  • After a thorough shuffle of the deck, each player is dealt 20 cards.
  • On the back of each card is the 12-month return delivered by the company on the face of that card.
  • Each player adds up the returns shown on their 20 cards.
  • The highest score wins!

If you honestly believe that you have a system of selecting stocks that guarantees long-term success, just remember that there are thousands and thousands of investors out there with exactly the same belief and intention. Ask yourself… are you really better than them or are you just another weekend warrior? Because, if you can’t clearly define what your edge is, be sure that you don’t have one.


Which Stocks Delivered the Extreme Returns?

OK, so now it’s time to name and shame. Over the course of Bessembinder’s 96-year study period which stocks delivered the best returns and which big names delivered lousy returns?

First up, the outperformers. The top five lifetime outperformers, in descending order were Apple, Microsoft, Exxon Mobil (the only one of the five that existed for the entire 96-year study period), Alphabet and Amazon. Apple and Microsoft blitzed the competition. Warren Buffett’s Berkshire Hathaway was just edged out into sixth position.

It's interesting to note that four of the top five are relatively young companies when considered within the 96-year time frame. Yet they created more wealth than a number of companies which had been around a lot, lot longer.

Of the 20 largest wealth destroyers over the recent period from 2016 to 2022 six were well known names. General Electric topped the list. Kraft Heinz, Uber, Doordash, Air BNB and Disney were also on the naughty list. While their share prices have generally recovered to varying degrees since the study (2022), I can’t help but consider the message delivered in Peter Lynch’s best-selling book One up on Wall Street. Lynch laboured the point that if you like the product then buy the stock. This investment strategy would have been lousy advice for the companies just mentioned. So, if you hold a conviction regarding a stock, realise that it can sometimes takes years for the investment case to play out.


What about including Compound Returns?

Bessembinder’s study calculated shareholder wealth creation (SWC) using net distributions added to share price changes. But it is not a compound calculation; dividends were not reinvested.

However, in a recent draft paper (dated November 2024), Bessembinder did include reinvestment of dividends and it changed the order of company performance. This boosted long-standing companies which is understandable considering that pay-out ratios in the US were once higher than they are now. Now, hold onto your hats, because the findings were staggering.

The winner is a tobacco company called Altria Group Inc, which in various forms, and sporting various names, spans the entire 98-year period of this study from 1925 to 2023. With an annualised compound return of 16.29 percent it delivered a staggering 265.5 million percent return for the period.

There are many companies with higher annualised returns than Altria however they haven’t been operating as long so their final compounded returns are lower. For example, Netflix (32% annually for 21 years), Amazon (32% for 26 years) and Microsoft (26% for 38 years).

This demonstrates that once you own a company that possesses great long-term prospects you should hang onto it. Which can be really tough for many investors as the following discussion suggests.


It Takes a Socratic Mindset and Nerves of Steel

How often have you heard someone say: “If only I’d bought Amazon when it was floated, then I’d be worth a fortune today?”. Equally Nvidia or Microsoft.

Well, the answer to those questions are as follows:

$1000 invested in each would now be worth (as at 18/7/25):

Amazon $2,287,287

Nvidia $4,604,130

Microsoft $8,475,848

However, I’d confidently wager that had you bought any of them when they were floated then you wouldn’t own them today. You wouldn’t have had the ticker to stay the course. Here’s why:

Let’s kick off with Amazon. Say you’d bought in at the float in 1997 during the heady days of dot.com. Between February 2000 and September 2001, the share price experienced a 91.3 percent collapse. Would you have kept the faith and held on? Or would you, as most would have done, bailed out as the share price was plummeting?

Apple is another example. It delivered a massive $1.47 trillion in shareholder wealth in the decade between 2010 and 2019 alone. But, since its 1980 float, it has also suffered three separate price collapses that have exceeded 70 percent. I’d suggest you would have ditched Apple as long ago as 1985 when its share price was down a confidence sapping 74 percent.

These aren’t isolated examples. Bessembinder has produced a list of the 100 companies that have created the greatest shareholder wealth over sample 10-year periods for the last several decades. None have gone up in a straight line. All suffered substantial drops on one or more occasions.

For the dedicated stock picker this information makes a mockery of stop-loss orders. While a generous stop loss can get you out of some dog stocks, Bessembinder’s research clearly demonstrates that an automatic stop loss would have also checked you out of some very attractive stocks. This begs the question whether you would have got back in as the share price recovered? Maybe you would have. But remember, there is a very human reason for the expression “Once bitten, twice shy.”

Skilled investors are better placed to take Ben Graham’s advice: ’Never buy a stock because it has gone up or sell one because it has gone down’. Graham is suggesting that those decisions should be based on a thorough assessment of the stock’s fundamentals. And, if you don’t possess a thorough appreciation of the fundamentals, then ask yourself what were you doing in the stock in the first place.

Graham’s advice also makes me question why people passionately advocate the blind purchase of trending stocks on the premise that they will continue to move upwards. It reminds me of the advice delivered by U.S. actor Will Rogers: “Don’t gamble. Take all your savings and buy some good stock and hold it till it goes up, and then sell it. If it don’t go up, then don’t buy it.”


Research referred to in article:

1. Shareholder Wealth Enhancement, 1926 to 2022 (June 2023) Hendrik Bessembinder 2. Which U.S. Stocks Generated the Highest Long-Term Returns? (November 2024) Hendrik Bessembinder 3. Extreme Stock Market Performers, Part 1: Expect Some Drawdowns (July 2020) Hendrik Bessembinder




Disclaimer: This article is prepared by Michael Kemp. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.

 
Previous Article