Picking the Losers is Easier Than Picking the Winners in the Stock Market

A reader asks:

Is there any way of telling when a stock has probably hit its peak, if not for good, for a long, long time? For example, GE hit its all-time peak back in the year 2000, and since then, it’s been on a long decline.  What are some signs that an investor can look for that a stock has probably gotten as high as it’s ever going to get? 

General Electric is a wonderful example here. The price was as high as $480 a share at the turn of the century:

It’s now under one hundred dollars, meaning the share price has fallen 80% from the peak.

This is a notable fall from grace for a stock that was consistently in the top 10 biggest names in the S&P 500 for decades:

From 1980 to 2015 General Electric was a top 10 holding in the S&P 500. It’s now the 86th largest name in the index.

GE’s share price woes may seem like an outlier but it’s actually the norm.

I count 56 stocks in the S&P 500 that are currently down 50% or worse from their all-time highs. There are 18 names that are down 70% or worse. And these companies are still in the index.

There are way more stocks that have fallen out of the S&P over time.

JP Morgan has a report called The Agony & The Ecstasy that’s easily one of my favorite pieces of long-term research on the difficulty of picking the winners in the stock market.

They find more than 40% of stocks in the Russell 3000 since 1980 have experienced a catastrophic loss, meaning the stock fell 70% from peak levels and never reached those levels again.

Some more stats from this report that are borderline mind-blowing if you’re a stock-picker:

  • Pick any stock from the Russell 3000 (which is basically the entire U.S. stock market) and two-thirds of the time that stock would have underperformed the index itself.
  • More than 40% of all stocks experienced negative returns on an absolute basis.
  • Just 10% of all stocks since 1980 can be defined as mega-winners.

Basically you have a much higher probability of picking a mega-loser than a mega-winner in your portfolio.

But because of survivorship bias, we hear far more stories about the winners than the losers. No one likes to brag about a stock that lost them tons of money. Everyone loves a story about a stock that made someone gobs of money.

The winners write the history books.

As to how to spot those companies that are on the precipice of a downfall, that’s very difficult to answer.

JP Morgan’s research found most of the time it wasn’t poor corporate management like Lehman Brothers. It was typically outside forces that caused problems:

  • Commodity prices
  • Government policy
  • Deregulation
  • Foreign competitors/globalization
  • Intellectual property infringement
  • Trade policies
  • Fraud
  • Technological innovation
  • Pricing power collapses

I would imagine some combination of innovation, obsolescence and disruption play the largest role in creating big losers in today’s market.

I had Josh Brown help me answer this one on this week’s Portfolio Rescue:

We also answered questions about buying your first home when you’re single, how much money to leave to your children and how many stocks to own in your portfolio.

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