How to pick the right stock? This ASU study may have some answers

Most investors know that the stock market has delivered solid results over time, beating returns for bonds and many other popular assets. Less obvious is that most of the long-term gains have been generated by a relative handful of stocks, with the typical company losing money over time.

Those are some of the upshots from a recent study by Dr. Hendrik Bessembinder, a professor in Arizona State University’s W.P. Carey School of Business. He tallied the returns of nearly 29,100 stocks, going back nearly a century for some companies, from December 1925 through December 2023. His research uncovered some surprises while affirming that the stock market is still a good place for patient and well-diversified investors to make money.

In tabulating these results, Bessembinder assumed dividends for each stock were reinvested and that investors pursued a buy-and-hold approach. The latest study builds on some of his earlier research that also revealed the rarity of truly great-performing stocks.

"I was indeed surprised when I first documented that a slight majority of publicly traded U.S. stocks generate negative rather than positive compound returns," he said in an email to the Arizona Republic.

But the negative or mediocre results of most stocks are overshadowed by the high returns from the big winners.

"Slightly more than 4% of the stocks that have been publicly listed in the U.S. since 1926 are responsible for all of the net wealth enhancement to shareholders," Bessembinder added. "That is, long-run wealth enhancement in the public stock market is concentrated in relatively few stocks."

Another surprise was that many stocks don't stay in the public markets all that long.

On average, stocks trade for an average of just 11.6 years, with the median or midpoint tenure even lower at 6.8 years. Of the nearly 29,100 stocks analyzed, only 31 made it through all 98 years, from December 1925 on. Companies often get delisted from or kicked off stock exchanges owing to poor performance, or they get merged of acquired out of existence.

Best individual stock results over time

The returns of winning stocks don't vary all that much on an annual basis, but these differences can really add up when compounded over many years.

Bessembinder cited two of the stocks that endured for the entire 98-year study period — Altria Group (formerly called Philip Morris) and Vulcan Materials. On an annual average basis, Altria’s return of 16.29% wasn't much above Vulcan’s 14.05%. Yet Altria’s cumulative compounded return was nearly 6.8 times that of Vulcan. For every dollar that an investor socked into Altria in December 1925, it would have grown to $2.65 million by the end of last year, compared to a $1 investment in Vulcan turning into nearly $393,000.

These results show the powerful impact of compounding and support the adage that what’s important is “time in the market,” rather than market timing. Incidentally, Altria’s 16.29% annual average return was the highest of any company over the 98-year period.

After Altria, the other top-five stocks dating to 1925, according to Bessembinder's research, were Vulcan Materials, Kansas City Southern, General Dynamics and Boeing.

More recently, the highest annualized compound return for any stock with a track record of at least 20 years was the 33.38% earned by shareholders in artificial intelligence stalwart Nvidia.

Nvidia and other tech stocks, especially those in the Magnificent Seven, have continued their momentum this year .

"This tendency for wealth creation to be concentrated in a few stocks has grown even stronger in recent years, Bessembinder said.

What high-octane stocks have in common

The big winners tend to generate a solid return on capital and a sustainable competitive advantage, and have benefited from management teams that have been able to sustain the positive momentum, observed Nicholas Colas, co-founder of DataTrek Research, commenting on Bessembinder's study.

“(This) illustrates why the average public company does not make money for its investors over time,” Colas wrote. “Most simply do not have that trifecta of value-creating qualities.”

The most successful companies also tend to increase their market share and profits over time while operating in a growth sector, Colas added, citing technology as a prime example.

Driven by the contribution of the relatively few high-performance companies, the stock market's long-term results have averaged around 10% a year.

A strategy to benefit from future stock winners

While Bessembinder’s latest study didn’t discuss indexing, his previous research gives a nod to this investing approach.

Indexing is the concept of holding a mix of stocks in a predetermined and largely unchanging portfolio, such as the 500 companies in the Standard & Poor’s 500 index. One advantage of index mutual funds or exchange-traded funds is that, because they aren’t actively managed, they tend to charge lower shareholder-borne costs.

Also, index-fund managers don't actively buy and sell stocks, as difficult as that can be.

"Stock picking is very difficult," even for professionals, and that makes index-based investing the only reliable way for most people to generate high returns, Colas wrote. "There are exceptional companies in every sort of market, but they are rare," he added.

Nor, clearly, are the big winners easy to spot, except in hindsight. "The only way to be certain of owning the stocks that turn out to be the future big gainers is to own all the stocks" in a broad index fund, Bessembinder said.

Reach the writer at russ.wiles@arizonarepublic.com.

This article originally appeared on Arizona Republic: How to pick the right stock? This ASU study may have some answers