The Median Stock Doesn’t Beat the Broad Market Indexes

According an analysis conducted by J.P. Morgan Asset Management, the median stock underperformed, since its inception, the Russell 3000 by 54%.

The median stock underperforms the market. According to an analysis conducted by J.P. Morgan Asset Management, the median stock underperformed, since its inception, the Russell 3000 by 54%. Furthermore, even when hindsight was used to create an optimal portfolio, diversification would have still benefited shareholders of nearly three-quarters of all Russell 3000 stocks.

The study was conducted to analyze the impact of having wealth concentrated in a small amount of equity investments. Though having high exposure to the right investment can create substantial amounts of wealth, it comes with high levels of risk. The analysis found a high rate of substantial declines in market value and a high likelihood of long-term underperformance.

Stocks were classified as experiencing a catastrophic loss if they fell by 70% or more from their record high peak and their eventual loss was price of 60% or below the high. Between 1980 and 2014, 40% of all Russell 3000 companies incurred a catastrophic loss. The loss rates tended to rise during recessions and market corrections. While this isn’t surprising, what should be is that there was generally a steady pace of distress observed during periods of economic expansion, with the exception of recent years. (The study’s author attributes the current 34-year low to the Federal Reserve’s loose monetary policy.) Loss rates were the highest among technology, telecom, energy and consumer discretionary stocks.

Stocks were also measured based on the time they first went public to their last reported price (either as of the study’s date or when the stock was delisted). Two-thirds of all stocks had negative excess returns versus the Russell 3000, meaning they underperformed the index. Returns were negative on an absolute basis.

There were stocks that beat the index. About 7% of all stocks were classified as “extreme winners.” These stocks enjoyed lifetime returns of more than two standard deviations over the average. They are “very heterogeneous,” however. The diverse mix of these stocks adds to diversification argument.

We’ll add that the study looked at the long-term performance of stocks. While we agree with the diversification argument, we also think it shows the importance of having a disciplined approach to both buying and selling.

Source: “The Agony and the Ecstasy: The Risk and Rewards of a Concentrated Stock Position,” Michael Cembalest, J.P. Morgan Asset Management, 2014.