What are typical return behaviors and firm characteristics of the best-performing and worst-performing U.S. stocks at a 10-year horizon? In his July 2020 series of papers entitled “Extreme Stock Market Performers”, Part I: Expect Some Drawdowns, Part II: Do Technology Stocks Dominate?, Part III: What are their Observable Characteristics? and Part IV: Can Observable Characteristics Forecast Outcomes?, Hendrik Bessembinder investigates returns and firm characteristics of stocks that generate the most and least total shareholder wealth (are the “best” and “worst” stocks) in each decade since 1950. Total shareholder wealth generation incorporates both cumulative return and market capitalization. Using monthly returns, market capitalizations and firm characteristics for U.S. stocks for each decade during 1950 through 2019, he finds that:
- For the 100 best stocks within each decade, the average maximum drawdown within the decade is -32.5% and lasts 10 months. During the immediately preceding decade, average maximum drawdown of these stocks is -51.6% and lasts 22 months.
- Technology stocks are more likely to be among the 200 worst stocks in a decade than the 200 best. Telecommunications, healthcare/pharmaceuticals and energy firms are over-represented among the 200 best stocks by decade, though telecommunications firms are also over-represented among the 200 worst.
- The best stocks are of firms with relatively rapid concurrent asset growth and cash accumulation, with higher than average profitability and spending on research and development (R&D). Top performing firms in terms of cumulative stock return (total shareholder wealth generation) tend to be relatively young with high stock return volatility (relatively old without abnormal return volatility).
- Firms with the highest cumulative stock returns by decade tend to be relatively younger with deep return drawdowns and high R&D spending the prior decade. Firms with the lowest cumulative stock returns by decade tend to be relatively leveraged at the end of the prior decade, with relatively low profitability, low R&D spending and high return volatility during the prior decade. However, more than 98% of the variation in next-decade performance remains unexplained.
In summary, evidence hints at some characteristics of the best stocks at a 10-year horizon, but exploitation is problematic.
Cautions regarding findings include:
- The sample is very small in terms of independent 10-year investment horizons (seven).
- The study does not test portfolios selected based on lagged stock return behaviors and firm characteristics.
- Economic/market environments in a given decade may not carry over to future decades.
