Chapter 10. Picking Stocks Is Harder Than You Think

GENERAL ELECTRIC (GE) was the largest company in the US stock market in the year 2000. Not only was it the biggest company in the market, but it was nearly double the size of the second largest corporation, Exxon. From the start of the new century in 2000 through the autumn of 2020, GE shares were down 80%, including the reinvestment of all dividends. Retirees who kept the bulk of their retirement assets in the stock are in a world of pain. Nearly one-third of GE’s company pension plan was invested in company shares as recently as 2016.

Yet GE is anything but an isolated case. US corporate history is littered with examples of once-great stocks like Enron, Lehman Brothers and WorldCom that similarly fell from grace. Researcher Geoffrey West analysed the longevity of publicly listed US companies since the mid-20th century and made the following discoveries:

· Nearly 29,000 companies traded on the US stock market from 1950 to 2009. By the end of that period, almost 80% had disappeared (through buyouts, mergers, bankruptcy, etc.).

· Fewer than 5% of companies in the stock market remained over rolling 30-year periods.

· The risk of a company dying did not depend on its age. The probability of a five-year-old company dying before it turns six was the same as that of a 50-year-old company failing to reach age 51.

· Larger companies were just as likely to die as smaller ones. Just 12% of firms listed on the Fortune 500 in 1955 survived.

· The estimated half-life of US publicly traded companies was 10.5, meaning half of all companies that went public in any given year were gone in 10.5 years.

But it’s not just the US that has a large failure rate for big corporations. At the start of 2019, only 30 of the original 100 UK stocks that made up the FTSE 100 when it was launched 35 years earlier were still in the index.

The bad news, then, is that simply surviving as a corporation is hard enough. Over the long term, the vast majority of stocks underperform the broader stock market. The good news is that there’s always a small number of hugely successful stocks that more than compensate – which brings us to the one question that people like Ben who work in the financial industry are asked more than any other.

What do you think of (such and such a company) I’m considering buying shares in?

There is typically a look of befuddlement on their faces when Ben politely declines to offer guidance with his standard, “I don’t know.”

The truth is he really doesn’t know. And nor does Robin.

Why not? Because, contrary to popular opinion, picking stocks is fiendishly hard. In fact, our suggestion is that you don’t even try.

One of the secrets to successful investing is that stock-picking isn’t nearly as important as people in the financial media would have you believe.

Here’s a shortlist of things that are more important:

· Your savings rate. Saving is the first step to investing.

· Your asset allocation. The mix of shares, bonds, cash and other investments will be the biggest determinant of your investment success beyond how much you save because it sets the tone for the risk profile of your portfolio.

· Your investment plan. Financial writer Nick Murray says, “A portfolio is not, in and of itself, a plan. And a portfolio that isn’t in service to a plan is just a form of speculation; it can have no other goal than to beat most other people’s portfolios. But ‘outperformance’ isn’t a financial goal.”

If a portfolio isn’t a plan then neither is stock-picking. We’ll admit, picking stocks is more fun than asset allocation, but it’s also much harder to pull off. For every Amazon that turns a small initial investment into millions of pounds, there are thousands of companies that would decimate your life savings.

An eye-opening study from JP Morgan found roughly 40% of all stocks in the US stock market have suffered a permanent 70%+ decline from their peak value since 1980. Two-thirds of all stocks underperformed the stock market itself in that time, while 40% of companies experienced negative returns.

There have, of course, been some big winners in this time, but it is a select group of stocks. Around 7% of companies in the US stock market have generated lifetime returns that would put them in the category of ‘extreme winners’. According to Hendrik Bessembinder’s research, four out of every seven stocks in the United States has underperformed the return of cash sitting in a savings account since 1926. There are simply more opportunities to pick the losers than the winners in the stock market.

And remember, there’s losing and there’s losing big. If you buy an individual share, it could go to zero. In other words, you could lose your entire investment.

The answer, then, is simple: diversify. Don’t focus on individual stocks; seek exposure to whole markets. Don’t pick out one or two sectors of the economy; have a stake in every major sector. Don’t just invest in the UK or the US stock market; be a truly global investor.

Instead of looking for needles in a haystack, just buy the whole haystack.

Or, to use a cricketing analogy, stop trying to hit a six off every ball. You simply need to stay in the game. So be happy to accept ones and twos, carefully avoiding rash investments that could decimate your life savings.

In short, forget getting rich quick and focus on getting rich slowly. How to go about it is the subject of our next chapter.

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