It can be quite educational to read articles you disagree with. I recently read some articles on both sides of an issue and found myself disagreeing with all of them.
Here’s what is suggested: The exceptional performance of the S&P 500 in the last ten years is the result of the outstanding rise of a small number of stocks, the FAANGs. It is said that if you missed investing in those stocks you were bound to underperform the index.
The suggestion reaches a general conclusion. It continues: To actively manage a portfolio, you have to have the skill to identify future FAANGs and the gumption to stick with them through thick and thin. Further, if you don’t have this skill, you are better off buying an index ETF and being satisfied with this market outcome.
The statistical research and the articles
The ‘suggestion’ comes from a research paper published in 2018 titled ‘Do Stocks Outperform Treasury Bills’ written by Hendrik Bessembinder. It contains a statistical analysis. The sweeping conclusion was that “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.” For paper see here.
In a rather heady article published in the Financial Times March 1, 2021, Lawrence Burns, an investment manager at Baillie Gifford wrote: “The entire active management industry should be trying to identify these superstar companies since nothing else really matters.”
Apparently Mr. Burns firm had achieved some fame by buying and holding Tesla stock during its dramatic rise. Burns notes: “The other 99% of companies were a distraction to the task of making money.” For Burns, profit-taking can be “the worst possible mistake.” Hence the gumption to stick with them through thick and thin. See article here. Of course, Mr. Burns is wrong.
Andrew Dickson of Albert Bridge Capital responded in a note that was also published in the Financial Times. See article here.
He had two lines of attack. First he dissected the Bessembinder research and concluded: “Very frankly, the data just doesn’t support his argument, and conclusions drawn from it are misinformed.” You can read the detail for yourself in Dickson’s note.
As for Burns main point about not selling winners, it is dismissed as being “after-the-fact diagnosis” and based on “a biased sample of self-selected winners”. Dickson concludes by pointing out that stocks can be cheap in one price range and dear in another and he decries the “never-sell-anything mantra”. He is not totally clear about what he proposes but the impression is that holding winners might not make sense. He seems to be saying it is best to sell stocks when they get overpriced. Of course, this is also wrong.
The next article to appear was a May 3, 2021, piece by John Rekenthaler V.P. Research at Morningstar. It was titled: ‘You Needn’t Hold Your Stock Winners’. It was this article, and especially the title, that peaked my interest.
Enter a further statistical analysis
Rekenthaler wrote: “The language of the Burns-Dickson dispute was new, but not the rivalry. Baillie Gifford buys growth stocks–in recent years scoring big with its Tesla (TSLA) position–while Albert Bridge prefers value stocks. Consequently, Baillie Gifford resists selling equities because they have become costly, while Albert Bridge suggests doing so. I agree with Baillie Gifford and growth investors on the facts.”
BUT, and it’s a big BUT, Rekenthaler goes on: “An additional question must be asked and answered. And when it is, the interpretation favors Albert Bridge/value buyers.” In other words, you don’t need to hold your winners!! See article here.
Rekenthaler goes on to perform a neat statistical analysis. His methodology is to compare actual stock market total returns for a group of stocks to the returns produced by random luck. His group consisted of “the 1,000 biggest U.S. companies that beat the Morningstar U.S. Stock Index during each calendar year to the percentage of such companies that outgained the index over an entire decade.”
His conclusion is that “chance alone will create stock market outliers.” He says “the distribution of U.S. stock returns–that is, the manner in which they compounded–is indistinguishable from what would have been achieved by chance.”
This analysis leads him to his conclusion that “You Needn’t Hold Your Stock Winners”. With the greatest respect to Mr. Rekenthaler, this statement is wrong.
George Canning was a British politician in the early 19th century. He famously said “I can prove anything by statistics except the truth.”
Let’s do a reality check. When thinking about stock winners and losers, as I note in the title to this post: ‘There’s a time to hold ‘em and a time to fold ‘em.’ This is the correct answer.
To actively manage a portfolio, you do not have to have the skill to identify future FAANGs. You simply have to have the skills to identify superb companies, buy them at very attractive prices and follow sound rules around selling.
The investment principles around selling losers and holding winners are one of the most important and subtle topics in investing; laden with psychological pitfalls.
I have dealt with the subject of selling in a detailed post titled ‘19 Cardinal rules on selling stocks’
To read more about the psychology of holding losers take a look at Section 12.10 Cutting the flowers and watering the weeds – holding onto losers
If you want to read more about how to manage a portfolio of common stocks take a look at Part 7: Building and managing a portfolio
In particular take a look at Chapters:
43. Uses and Misconceptions about Charts
44. Monitoring your Portfolio
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