Why it’s Harder to Pick a Winning Stock Than a Losing One

“The sky has finally fallen,” said Eeyore. “Always knew it would.”

While you might not want to adopt the pessimism of Winnie-the-Pooh’s gloomy friend in every aspect of your life, when it comes to picking stocks, having a glass-is-half-empty attitude can give you a statistical advantage.

It’s not because the market as a whole has been contracting. In fact, quite the opposite has been true over the past several decades. It’s because, for any given timespan, the number of stocks that underperform the market will outnumber those that beat it.

This seems counterintuitive. But this is a real phenomenon whose existence has been borne out by research.

Ben Carlson, writing for A Wealth of Common Sense, cites a report from JP Morgan aptly titled The Agony & The Ecstasy, which tracks the performance of individual winners and losers over the long-term. According to their research, in the period from 1980 to 2020 more than 40% of the stocks in the Russell 3000 (an index that tracks the majority of U.S. stocks) have experienced “catastrophic loss”—meaning the stock fell 70% from its peak levels and never reached those levels again.

A classic example is General Electric. Around the year 2000 a share of GE was worth as much as $480. It’s now trading under $100, which means the stock price has dropped 80% from its peak.

As dramatic as that loss is it’s far from abnormal. According to Carlson, if you pick any stock from the Russell 3000, two-thirds of the time that stock will have underperformed the index. And more than 40% of all stocks have experienced negative returns on an absolute basis.

But, you say, since the market has risen steadily over the past few decades, there must be a significant percentage of big winners.

Unexpectedly, no. According to Carlson’s own analysis, 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,” writes Carlson. “But because of survivorship bias, we hear far more stories about the winners than the losers.”

He adds that while everyone loves a story about a stock that made someone rich, no one likes to brag about a stock that lost them tons of money.

The old saying “Winners write the history books” is certainly true in the world of finance. This skewed view of the prominence of winning stocks causes many speculators to believe they have a good chance of identifying them ahead of time. Unfortunately, the vast majority end up learning the hard way that this is a fallacy. Picking individual stocks is risky and potentially dangerous to your long-term wealth building strategy.

Knowing that the market is truly unpredictable, the prudent investor will use a strategy that expects random movements, striving to endure them through diversification and discipline. That’s why we contribute aggressively to a broadly diverse portfolio, specifically tailored to your income and timeline, maintained for the long-term with our help.