Mean aversion – why you should own only the very best businesses
Business profitability does not revert to the mean. The opposite is true, but only for the best, most profitable businesses. Aversion to the mean is asymmetric. Why? Improvements in productivity have accrued almost exclusively to the most productive businesses. Our conclusion – own only the best and forget the rest. Show More
Most stocks underperform, and why this is an argument for conservative active management
While equity index returns over time broadly match a normal distribution, returns from individual stocks are highly positively skewed. Skewness increases with the length of holding period - held for a decade two-thirds of stocks underperform the index. Search for the extreme winners? Our conclusion – avoid the losers. Show More
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James - thanks for your thoughtful question. Bessembinder does not examine the characteristics of the left tail of the distribution. I share your observation that low-PE multiples are often associated with businesses in trouble and offer no protection to capital destruction. Retailers and media companies over the last five years come to mind. My own work using Factset data over the last ten years shows that stocks in the top quintile by PE multiple are 49% more likely to be in the bottom 20% of share price outcomes, while stocks in the least expensive quintile are 37% less likely to be in the worst 20% of outcomes. Taking it further, one variable only deals with one dimension, and to your point profitability matters, as does capital structure and management capital allocation. Stocks with the lowest quintile of ROIC are 44% more likely to be in the bottom 20% of outcomes; stocks in the most profitable quintile are 45% less likely. Lastly, this only tells you what's in the rear view mirror - a judgement about the durability of that ROIC is critical, which is why I don't believe in factor investing/ smart beta. That's a topic for another time! Stephen
On Most stocks underperform, and why this is an argument for conservative active management -
Excellent article Stuart
On Wesfarmers’ UK debacle shows the risks of acquisition-based growth -