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1% chance you win. Will you gamble?

1% chance you win. Will you gamble?
By Making smalltalk • Issue #20 • View online

That stocks outperform bonds/FDs is rather common knowledge for most equity investors. But a recent study, published on 5th July 2019 by researchers at the Arizona State University & Hong Kong Polytechnic University has revealed a startling fact:
Between 1990-2018, the global stock market experienced tremendous growth & created wealth amounting to $US 44.7 trillion - but only 811 stocks out of approx. 62,000 listed stocks (1.3%) were responsible for this wealth creation.
Other interesting stats from the study:
  • Only 306 companies (0.5%) accounted for 73% of net wealth creation globally from 1990 until 2018
  • Less than 1% of non-US companies contributed to the global total
  • Of the 50 largest wealth creating stocks, 34 were in the US
  • Just 5% of firms in each of the 42 countries studied accounted for 42% of the wealth creation
  • TCS and Reliance were the leaders from India, respectively contributing 0.16% & 0.14% of total wealth created (more below)
Overall, the study provided an even stronger evidence for what finance professors & many investment professionals have suspected for a while - that the stock market experiences strong positive skewness & only a handful stocks out of thousands tend to drive most of the equity market returns.
The findings also has implications to the raging debate between active stock selection vs. the passive/systematic approach.
While active management does work, it’s extremely difficult to consistently identify winning stocks & then hold on to them. Investors who don’t have any advantage/skill in identifying the few stocks that will create most wealth - or in selecting an active mutual fund with the ability to do so - the study reinforces the appeal of passive investing.
I wasn’t surprised by most of the findings when I first read the paper - what really stunned me was the extent. That only 1.3% of 62,000 stocks have led to overall wealth creation in the last 28 years shows the magnitude of the challenge faced by active management.
So how does this impact you?
  • Picking (and holding on) the right stock can surely generate tremendous wealth - but more likely than not, people are going to pick a stock that generates middling or negative returns. Moreover, to pick such stocks consistently is difficult, and this becomes even harder as the time horizon extends.
  • I can’t stress this enough - diversification is important! Not only does it reduce your risk, but also increases the probability that you’ll own the small number of stocks that drive returns.
Happy investing!
-Vikas Bardia
PS: In case you’re interested, the below stocks have been the Top 20 contributors to global wealth from India!
Source: Do Global Stocks Outperform US Treasury Bills?
Source: Do Global Stocks Outperform US Treasury Bills?
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