Bessembinder Finance

Hendrik Bessembinder's groundbreaking work in finance has challenged conventional wisdom and sparked considerable debate about the true drivers of stock market returns. His research, most notably his 2018 paper "Do Stocks Outperform Treasury Bills?", reveals a surprising and somewhat unsettling truth: a significant majority of individual common stocks fail to outperform safe Treasury bills over their lifetimes.

Bessembinder's methodology involved meticulously analyzing a comprehensive dataset of common stocks listed on the NYSE, Amex, and Nasdaq exchanges from 1926 to 2015. He tracked the total returns of each stock, including dividends and capital gains, and compared them to the returns of one-month Treasury bills. The findings were stark: roughly 58% of individual stocks delivered lifetime returns that were lower than those achievable with risk-free Treasury bills. Furthermore, when adjusted for transaction costs and taxes, the percentage of underperforming stocks increased even further.

This isn't to say that the stock market itself doesn't generate positive returns. The key is the highly concentrated nature of wealth creation within the market. Bessembinder discovered that a small fraction of stocks, roughly 4%, accounted for essentially all of the aggregate net wealth creation observed in the U.S. stock market. These "extreme winners," as they are often referred to, generated returns so substantial that they more than offset the losses incurred by the vast majority of underperforming stocks.

The implications of Bessembinder's research are profound. It challenges the traditional investment narrative that suggests diversified portfolios of stocks are inherently superior to lower-risk alternatives. While diversification is still crucial for mitigating risk, it's important to recognize that a broad portfolio is likely to contain a significant number of stocks that will ultimately drag down overall performance. The success of a well-diversified portfolio hinges on capturing at least a few of those rare extreme winners.

Bessembinder's work also highlights the importance of luck and skill in investment management. Identifying the future extreme winners is exceptionally difficult, and even skilled analysts may struggle to consistently predict which companies will generate extraordinary returns. This underscores the potential value of strategies like passive investing, which aims to capture the overall market return without attempting to pick individual winners.

Finally, Bessembinder's findings offer valuable insights for corporate finance. Companies should strive to generate returns that exceed the cost of capital and create lasting value for shareholders. While not every company can become an extreme winner, focusing on sustainable growth, innovation, and efficient capital allocation can significantly increase the odds of long-term success. The lesson from Bessembinder is clear: creating lasting shareholder value is a challenging endeavor, and sustained outperformance is a rare achievement, driven by a select few exceptional companies.