At times like this when there is great uncertainty, wouldn’t it be great if we had the means to look into the future? Perhaps not some might argue. Unfortunately, we don’t know the future – no one does.
When it comes to investing, it can be tempting to run ‘what if’ scenarios in our heads, such as ‘perhaps I should move into technology and pharmaceutical companies – as surely these will do well’ or to pick out specific companies that appear likely to thrive in the future.
However, two challenges exist. The first is that you won’t be the first person to have thought this and the combined views are already reflected in market prices. The second is that in making such focused bets you have a high chance of being wrong and missing out on the companies that actually end up driving future returns. Remember, 30 years ago Amazon and Google did not exist.
To get a feel for what these focused risks look like, academics are able to explore a vast amount of equity market data in the US, known as the Centre for Research in Security Prices (CRSP) database.
One such study reveals some surprising and useful findings between 1926 and 2015. Whilst investment wisdom and empirical evidence support the case that equities, in aggregate, outperform cash over longer periods of time, a closer look at individual equity returns tells a very different story. Here are some of the insights that the paper provides:
The median time that an equity/share is listed on the CRSP database is only seven years, during the period 1926 to 2015. That’s not long.
Just over 40% of all equities/shares have a holding period return that exceeds the return of cash (in this case one-month US Treasury bills) over the period that the equity/share was in the database. More than 50% deliver returns that are negative. The median lifetime return on any single equity/share was -3.7% p.a. That’s not good.
26,000 equities/shares have appeared in the CRSP database since 1926, yet only 36 survived the entire 90-year period. That’s not many.
US $32 trillion of wealth was created between 1926 and 2015, which has been generated entirely by the top 1,000 companies, representing less than 4% of the total number of companies listed over time. The top thirty companies (0.1% of all companies) accounted for around 30% of the total stock market’s wealth creation. That’s pretty concentrated.
This is why, at times like this, and in fact across all time periods, we believe it makes enormous sense to remain highly diversified, so as not to miss out on the next Exxon (the firm that has added most value to the US market ever), Apple or Amazon.
Now, let’s look at how the top ten US firms by revenue changed between 2000 and 2010 and again between, 2010 and 2020. The results are so revealing. Just look at the new companies making it into the top 10 in 2010 and then in 2020. Look at the names which disappeared from the top 10 in 2010 and again in 2020.
Top 10 US companies by revenue over time (2000, 2010, 2020)
Source: Fortune 500
Correctly picking which few companies are going to be driving market returns over the next decade or two will not be easy, or likely. Even if you could, remember the majority of us are investing for more than 20 years.
At Wells Gibson, we believe it makes perfect sense to own the top companies by owning a broadly diversified portfolio which invests in thousands of companies. Missing out on these companies, perhaps that don’t even yet exist, could make all the difference between a good investment outcome and a very poor one.