In case you failed to notice, Nvidia has had a stellar year, almost tripling its stock price. Even more impressive, however, is the fact that during the previous 25 years – it was listed at the start of 1999 – Nvidia had a cumulative return of 131,500%, or an annualised compound return of close to 33.4%. It’s thus the most lucrative US stock with over twenty years of return data, according to recent research.
This research comprises more than 29,000 stocks listed at some point over the 98 years from December 1925. The mean outcome across stocks is a cumulative compound return of 22,840 per cent, meaning that one dollar invested would have grown to more than 229 dollars. As stocks don’t last forever, you can’t automatically translate this into an annualised return figure, but I can add that the S&P 500 returned an average of 10.2 per cent over these 98 years.
The median outcome, however, was nowhere near 229 dollars. It was a loss of 7.4%, as almost 52% of the stocks in the database realised negative compound returns. Let it sink in: The mean stock was very profitable. The median stock returned a loss.
The reason, of course, is stocks like Nvidia. Such heavenly figures make up for a lot of loss-making stocks. In professional terms, equity returns are characterised by a very pronounced skewness. The distribution of outcomes does not resemble a bell curve; the tail to the right is exceedingly fat. It contains an astonishing number of very high returns. Like Nvidia. These stocks then generate more than their fair share of the aggregate returns.
The researcher, Hendrik Bessembinder, has made waves with related research that demonstrated a surprisingly large number of stocks failed to beat Treasury Bills – long-term. Here’s from the abstract: “The majority of common stocks (…) have lifetime buy-and-hold returns less than one-month Treasuries. [I]n terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926, as other stocks collectively matched Treasury bills.”
That’s skewness for you. One way of looking at it is that you have to be very careful in the stocks you pick. Stocks chosen at random are likely to be dogs. Another interpretation would hold out indexing as a way around the exceedingly difficult problem of finding the right stocks. We are of course partial to the first interpretation.
There is, however, a methodological challenge with this research that does not seem to be addressed. The number of listed companies changes dramatically over time, peaking in the past millennium and then receding. What if more companies are listed after a good stock market run and then deliver poor performance in a more bearish market?
Either way, with a changing number of listed companies, they are not evenly distributed across bull and bear markets. I wanted to check this effect and so weighted the monthly returns from 1926 with the relative number of listed companies. When calculating cumulative returns, this approach assigns greater weight to periods with an above-average number of listed companies, and vice versa.
Towards the end of the 1970s, the number of listed companies had risen eightfold (to a level higher than today’s). And the weighted returns were way below the S&P 500. The relationship then reverted somewhat, but not enough: Whereas the S&P 500 would have transformed a 100-dollar bill into almost 94,000 dollars, the weighted index stood at 66,000. Arguably, the latter figure aligns more closely with the numbers Bessembinder reports in his research.
So, yes – it seems more companies were listed ahead of weaker periods in the stock market or delisted before further market appreciation. That’s certainly worth bearing in mind before you conclude that the median stock does not pay off.
The broader conclusion of a skewed market still stands. You might say it’s a logical necessity, as a stock can only lose 100% of its value but gain significantly more (as aptly illustrated by Nvidia).
The takeaway is clear, if tempting to skirt in practice: Build a diversified portfolio. The positive contributors are fewer than you think.
