The Perils of Buying Direct Stocks
We have written several articles about the risks of buying individual stocks. When research shows only 4% of the listed stocks in the US over the past 100 years account for the entire net gain of the stockmarket, and 4 out of 7 stocks have lifetime returns less than 1 month US Treasury bills – the lowest risk investment in the world – it is clear any strategy of holding a concentrated portfolio of stocks is high risk.
We decided to turn our minds back 20 years to identify a number of stocks – still listed today – who had strong growth prospects at the time and see how they performed. We brainstormed what these stocks may have been without any idea of what the results may be (apart from perhaps AMP…)
It is a meaningful exercise because when we review a new client’s existing portfolio, it commonly holds a small number of blue-chip Australian stocks. Creating portfolios like this is how many Australians invest.
The 11 stocks we selected were:
As you can see, each stock we selected was a well-known household name with a strong narrative in 2002 to justify holding it in your portfolio. The same sort of narratives we see in stockbroker reports and newspaper articles all the time.
If you invested a total of $1 million equally across all of these 11 stocks (or $90,909 per stock) in January 2002, how did you perform over the 20-year period to 31 March 2022? And how did this compare to the Australian market? The table below has the answer:
The stockmarket returned almost double what this concentrated stock portfolio delivered.
The best performing stock was Tabcorp, which had an average annual return of 7.7%. But even this was below the market return of 8.6% pa.
Not one of the 11 stocks beat the index over the 20-year period.
Identifying a winning stock is hard. Between 1983 and 2006 in the US, the average return of the 3,000 largest public stocks was -1.1%. So if you had $3,000 in 1983 and put $1 into each stock, you lost money over the next 25 years. But if you’d simply bought the market, your annual return was 12.8%. Why? Because you were buying stocks based on their market capitalisation, meaning you were buying more of the stocks that were increasing in value, and less of the stocks decreasing in value.
You may ask why we did not select CSL in our portfolio above? CSL has been one of the best performing stocks on the ASX over the past 20 years. Did we purposely avoid this stock?
Well around 2002, the outlook for CSL was not good. There was no compelling reason to hold CSL. In early 2003, the Australian Financial Review reported the market was ‘punishing CSL because of the low price of plasma’ and the company was ‘struggling to interest investors in its projects’.[ii]
The CSL share price at the beginning of 2002 was $17. It is now $265, but factoring in a 3 for 1 share split back in 2007, the total return has been 4576%. This is more than 10 times the market return.
But holding CSL is no guarantee of success. If you bought CSL shares on 28 February 2020 - just before the market fall due to COVID - when it really was the darling of the Australian stockmarket, your return since then has been -15% versus the market return of +14%. And remember - that market return of +14% included a sizeable holding in CSL given its weighting in the ASX300 - it just shows how well other stocks in the market had to perform to counter CSL’s underperformance.
Some intelligent people may think they are not making their money work hard enough by holding widely diversified portfolios. The ‘smart’ money is following the stockbrokers and opinion pieces in the media on the next big thing.
We respectfully disagree.
Our approach of starting with the market and then tilting towards factors which offer higher expected long-term outcomes is where the intelligent money is. The largest sovereign wealth fund in the world, operated by Norway and holding 1% of all publicly listed stocks – adopts the same principles we do.
It remains the best approach to help our clients achieve the returns they need to enjoy their ideal life.
Author: Rick Walker
[i] Stock returns sourced from Morningstar
[ii] https://www.afr.com/companies/csl-seeks-a-self-cure-20030206-ka7sb