The cult of single stocks is strong. Big tech’s massive decade, the explosive performance of a handful of meme stocks and the launch of the world’s first single-stock ETF are among recent examples of why people continue to believe the myth that successful investors need to pick winners.
While it is true that a minority of stocks contribute significantly to the performance of the whole market, it is important that investors understand how hard it is to find them, the multiple benefits of diversification and the risks of over-concentration.
Using nearly a century of US equity data, new research highlights some unexpected facts about the performance of single stocks. For example, 20% of stocks survive and outperform over 20 years, but 20% of stocks delist within five years of listing, and the average stock underperforms the market over five, 10 and 20 years.
The good, the bad, and the lucky
Industry development and innovation are signs of a healthy economy. Financial markets reflect this dynamic through the birth and death of public companies. This translates to meaningful turnover among individual stocks.
The average survivorship statistics over rolling periods imply a little more than one in five US stocks available in the market at a given time delist within five years. The survival rate goes down over longer periods, with just under half of stocks on average still trading 20 years later.
Not all delistings produce the same experience for investors. We categorize these delisting events as “good” or “bad” based on the circumstances for each stock.
For example, a stock delisting due to a merger would be a good delist, as the shareholders of that stock would be compensated during the acquisition. On the other hand, a firm that delists due to its deteriorating financial condition would be a bad delist since it is an adverse outcome for investors.
Over 20 years, about 18% of stocks went the bad-delist route on average, as the below chart shows.
Average survivorship and outperformance rates for cross-sections of US stocks over rolling periods formed each month, January 1927–December 2020
Source: Dimensional, using data from CRSP and Compustat. The US market includes all US common stocks without gaps in monthly data for a given rolling period. Delisted stocks with delisting code between 200 and 399 are considered good delists; bad delists are 400 or greater. Outperformance defined relative to the value-weighted market at each cross-section. Statistics reported are averages computed across rolling multiyear periods formed monthly from the cross-section of stocks available at the start of that month.
Most stocks underperform the market
The range of returns for single stocks is vast, even among those surviving a long time. The chart below shows distributions of excess returns for surviving stocks over rolling periods of five, 10, and 20 years formed using the average cumulative return in excess of the market at each percentile.
All three lines are to the right of the crosshair meaning that the median stock underperforms the market across all three horizons. Not until we reach the 57th, 57th, and 56th percentiles at the five-, 10-, and 20-year horizons, respectively, do we see positive excess returns relative to the market.
Average return in excess of the US market by percentile for the cross-section of surviving stocks over rolling periods, January 1927–December 2020
Source: Dimensional, using data from CRSP and Compustat. The US market includes all US common stocks without gaps in monthly data for a given rolling period. Excess return for each stock is the difference in annualized compound returns between the stock and the value-weighted market. Statistics reported are averages computed across rolling multiyear periods formed monthly from the cross-section of stocks available at the start of that month.
Do winners continue winning?
Investors lucky enough to have held the winners on the right side of the chart may eschew diversification, viewing it more like “worsification.”
In many cases, these stocks represent successful companies that investors believe will continue to prosper and buck the broad trend of adverse outcomes for single stocks.
Unfortunately, a long-term track record of outperformance generally has not been an indicator of future outperformance. Take, for example, stocks that have outperformed the market over the previous 20 years.
The chart below shows that, on average, about 30% of these stocks continue to survive and outperform over the following 10 years.
Of the stocks that have underperformed over the previous 20 years, the average subsequent outperformance rate is also 30%. In other words, winners have been no more likely than losers to beat the market in the future.
Outperformers do tend to experience a lower bad delist frequency than underperformers, which likely reflects the impact of strong performance on firm size.
For example, looking at the same data set of US stocks from CRSP and Compustat, the median market cap of past winners was $4.2bn as of December 2020—compared to $800m for past losers.
However, the bad delist rate is still 3% even for past outperformers; the bankruptcies of large companies such as Enron, Chesapeake Energy, and Circuit City remain fresh memories for many investors and former employees of those firms.
Unconditional and conditional performance of individual stocks using 10-year rolling periods, January 1947–December 2020
Source: Dimensional, using data from CRSP and Compustat. Includes all US common stocks. Delisted stocks with delisting code between 200 and 399 are considered good delists; bad delists are 400 or greater. Stocks with complete prior 20-year monthly data classified as past outperformers and underperformers relative to the value-weighted market. 10-year survivorship and outperformance defined relative to the value-weighted market at each cross-section using stocks without gaps in the following 10-year monthly data. Survivorship and outperformance and bad delists are averages computed across rolling 10-year periods formed monthly from the cross-section of stocks available at the start of that month.
Why diversification pays
Regulators are becoming increasingly worried about the blurring lines between gambling, speculating, and investing and this sentiment has been amplified in recent years as new platforms provide retail investors with access to trades that have previously only been open to professional investors.
Aside from speculative bets, there are good reasons why investors may end up holding large, concentrated positions in single stocks, whether as the result of employee compensation or a handsomely rewarded stock selection.
Familiarity with these stocks or a successful track record while holding them may discourage investors from diversifying.
Unfortunately, this can lead to one of the most well-known cautionary tales in finance: tragic declines in wealth from losses in single securities. And data on the behaviour of individual stocks suggests it’s hardly rare for firms to underperform—or even go under—regardless of past performance.
A well-diversified portfolio can help investors reliably capture market returns, limit individual stock risk, and improve the ability to tilt toward segments of the market with higher expected returns. Even when accounting for capital gains taxes, transitioning from a concentrated portfolio to a broadly diversified one can deliver higher growth of wealth. The long-term benefits of diversification can outweigh the short-term costs associated with liquidating outsize positions.
Wes Crill is head of investment strategists at Dimensional. The views expressed above should not be taken as investment advice.