Long Term Stock Investing

Hendrik Bessembinder and Michael Mauboussin have produced some of the most influential research on long-term stock investing, fundamentally challenging conventional wisdom about equity markets. Their findings reveal that wealth creation in the stock market is far more concentrated—and the risks of stock picking far higher—than most investors realize. Below is a comprehensive exploration of their key insights, the implications for investors, and the broader lessons for portfolio construction.

The Core Findings: Extreme Skewness in Stock Market Returns

Bessembinder’s Groundbreaking Research

Hendrik Bessembinder’s research, particularly his 2018 and 2021 studies, analyzed the lifetime returns of every U.S. common stock traded since 1926. His results were startling:

• Out of more than 26,000 U.S. listed companies, only a tiny fraction generated the vast majority of shareholder wealth.
• The top 90 firms (just one-third of 1%) accounted for half of all shareholder wealth creation relative to U.S. Treasury Bills since 1926.
• The top 1,000 stocks—less than 4% of all companies—were responsible for all net wealth creation above Treasury Bills. The remaining 96% of stocks, collectively, matched the return of risk-free T-bills or lost money[1][2][3].

This means that most individual stocks do not outperform risk-free investments over their lifetimes. Instead, a handful of “superstar” companies drive the entire market’s long-term gains.

The Role of Compounding and Survivorship

Bessembinder’s methodology compounded returns over each stock’s lifetime, rather than simply averaging annual returns. This approach revealed that while the overall market delivers strong returns, these are almost entirely attributable to a few extraordinary winners. Most stocks, when held for their full existence, underperform or fail to create wealth[1][2][3].

Michael Mauboussin’s Extension: Corporate Demographics and Wealth Creation

Michael Mauboussin, often collaborating with Dan Callahan, built on Bessembinder’s findings by examining the “birth, death, and wealth creation” dynamics of public companies:

• They confirmed that about 2% of all listed companies accounted for more than 90% of wealth creation.
• Mauboussin emphasized that wealth creation is not just about high returns, but about returns compounded over extended periods—requiring both exceptional performance and corporate longevity[4][5].

This research highlights the importance of company survival, not just performance, in contributing to long-term wealth creation. Many companies disappear from the market through bankruptcy, mergers, or acquisition, further concentrating wealth among the survivors.

Implications for Investors

1. The Case for Diversification

Both Bessembinder and Mauboussin stress that these findings make a compelling case for broad diversification:

• Since it is nearly impossible to identify the tiny subset of future superstar stocks in advance, holding a diversified portfolio (such as an index fund) ensures exposure to the rare winners that drive market returns[6][4][2].
• Diversification reduces the risk of missing out on these outliers and avoids the uncompensated risk of holding a concentrated portfolio of likely underperformers[6][2][3].

2. The Challenge for Active Management

The research explains why most active managers underperform the market over time:

• Active strategies tend to be less diversified, increasing the risk of missing the few stocks that generate most of the wealth[6][2][3].
• Even skilled managers face daunting odds: not only must they identify future winners, but they must also hold them through periods of volatility and avoid premature selling[4].

3. The Allure and Danger of Skewness

Bessembinder notes that some investors are attracted to the “skewness” of returns—the possibility of hitting a big winner, akin to buying a lottery ticket. However, the data show that most attempts to pick such winners will fail, and the expected outcome is underperformance[6][2].

Portfolio Construction: Two Strategies

Mauboussin and Bessembinder’s research suggests two main approaches to portfolio construction:

• Broad Diversification: Invest in index funds or broadly diversified portfolios to capture the market’s overall return, ensuring exposure to the rare wealth creators[4].
• Concentrated Bets: Attempt to identify and hold a small number of potential superstar companies. While this offers the chance of outsized gains, it comes with significant risk and a high probability of underperformance[4][2].

Mauboussin notes that while some investors or managers may prefer the latter approach for its potential, the difficulty of consistently identifying and holding the right companies makes it a perilous strategy[4][5].

The Nature of Wealth Creation: Birth, Death, and Corporate Longevity

Mauboussin’s work, especially in “Birth, Death, and Wealth Creation,” highlights the role of corporate demographics:

• Most public companies have relatively short lifespans. The average company’s time as a public entity is shrinking, and many disappear without creating lasting wealth[4][5].
• The companies that do create significant wealth tend to do so by surviving and compounding returns over decades, not just a few years[4][5].

This underscores the importance of patience and long-term holding periods for investors seeking to benefit from the market’s wealth creation.

Additional Insights: Market Concentration and Capital Allocation

Mauboussin’s more recent research explores related themes:

• Market Concentration: The current era is marked by high market concentration, with a few giant firms dominating index returns. While this has varied historically, it reflects the same underlying skewness in wealth creation[5].
• Capital Allocation: Effective capital allocation by management (such as share buybacks or prudent equity issuance) is a key driver of long-term shareholder returns[5].

Practical Lessons for Investors

Avoid Chasing Past Winners

Both researchers caution against simply chasing stocks that have performed well in the past. The odds of identifying future outliers are low, and the risk of missing them is high if one is not broadly diversified[6][4][2].

Understand the Role of Luck and Skill

The extreme skewness in outcomes means that luck plays a significant role in investment results. Even skilled investors may underperform if they miss the rare winners, while others may outperform due to fortunate stock selection[6][4][2].

The Importance of Holding Periods

To benefit from the compounding of superstar stocks, investors must be willing to hold for long periods, often through significant volatility. Many of the top wealth creators experienced severe drawdowns before delivering outsized returns[4][5].

Conclusion: Rethinking Long-Term Stock Investing

Bessembinder and Mauboussin’s research fundamentally reshapes our understanding of long-term stock investing:

• The vast majority of individual stocks do not outperform risk-free assets over their lifetimes.
• All net wealth creation in the stock market is attributable to a tiny minority of companies.
• The only reliable way to capture the market’s long-term returns is through broad diversification, which guarantees exposure to the rare but crucial winners.
• Concentrated portfolios offer the possibility of outsized gains but come with a high risk of underperformance.

Their work explains why passive investing has become so popular and why active managers struggle to beat the market. For most investors, the data strongly support a diversified, long-term approach—accepting that while most stocks will disappoint, the few that succeed will more than make up for the rest.

“The stock market as a whole is doing very well for investors. Most stocks are not doing well for investors. The only way this adds up is that there's a relative few stocks doing very well.” – Hendrik Bessembinder[1]

In summary, Bessembinder and Mauboussin’s findings underscore the importance of humility, patience, and diversification in long-term stock investing. The odds are stacked against those who try to outsmart the market by picking winners, but for those who embrace the market’s skewness through broad exposure, the rewards can be substantial.

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1. https://www.morningstar.com.au/insights/stocks/233587/only-24-of-companies-deliver-all-net-shareholder-wealth   
2. https://alphaarchitect.com/a-history-of-wealth-creation-in-the-u-s-equity-markets/         
3. https://wpcarey.asu.edu/department-finance/faculty-research/do-stocks-outperform-treasury-bills    
4. https://marcellus.in/story/birth-death-and-wealth-creation/           
5. https://www.themebfabershow.com/episodes/3g6O04KWI6D       
6. https://rationalreminder.ca/podcast/346

* This article is not financial advice. Please do your own analysis and speak with a financial professional regarding your own situation.