What If You Don’t Invest In The Best Stocks?

When you review the history of the American stock market from 1926 through the present day, you will find that nearly all of the gains came from just 4% of the publicly traded businesses in existence. For most of the 20th century onward, someone who held shares in Exxon, AT&T, General Motors, IBM, and Apple could claim to represent a meaningful chunk of the stock market.

The data on the poor performance of most stocks ignores the reality that most good businesses merge into the industry titans once they have been successful for a long time and the additional reality that many stocks are too small to provide a meaningful to the S&P 500 performance which is valued at $20.5 trillion.

This data point has been profiled in the working paper of Professor Hendrik Bessembinder at Arizona State University whose work has the non-ironic title “Do Stocks Outperform Treasury Bills?”

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Apple Stock’s Slice of America

About a year ago, Apple stock (AAPL) traded at $92 per share. Right now, it is trading at $155 per share. This significant June-to-June swing of 68%–a little over 70% when you include dividend payouts—gives students of the market much to analyze and reflect upon.

Apple stock has added 70% in shareholder value over the past year. Despite this, its overall profits haven’t changed much and its weighting in the S&P 500 has largely held steady.

My takeaways:

The theory that the stock market is a near-perfect calculator of the intrinsic value of a business is once again debunked. Apple is the largest business in America. Its profits have vacillated between $45 billion and $48 billion the past three years. The new project announcements and cash build-ups have proceeded as expected. There haven’t been any crazy events, such as annexing Google, that would justify a massive reorientation due to unpredictable circumstances.

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Corporate Insiders Have Forgotten The Warren Buffett Feud With Seabury Stanton

Many of you reading this are familiar with the backstory of how Berkshire Hathaway came to be the chosen investment vehicle that built Warren Buffett’s vast fortune. Buffett noticed that the price of Berkshire tended to bump in price every time there was an announcement of a mill closing, and he thought there was a gap in value between the $7-$8 prevailing price and the $20-$21 stated book value of the stock.

The decision to cheat Warren Buffett out of roughly a dime per share in a tender offer led to Seabury Stanton’s ouster as head of the Berkshire Hathaway textile mills. This potential consequence of personally insulting an activist investor was on my mind as I saw Sally Smith’s resignation from CEO of Buffalo Wild Wings after taking gratuitous shots at activist investor Marcato Capital. My view is that it is far better for the job-holder and the corporation itself to focus on the merits of the insurgent activist’s arguments rather than engage in ad hominem battles of identity.

Because Berkshire’s stock price was so low compared to the book value, patrician CEO and Chairman Seabury Stanton would use the liquidated proceeds from the mill closings to buy back its stock. Although this may be obvious, it is useful to keep in mind the premise—anytime a smallish company wants to repurchase a meaningful percentage of its stock, it needs to locate shareholders willing to part with the stock lest the business end up bidding against itself or—even worse!—run afoul of SEC rules and congressional laws on stock price manipulation.

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The Secret to Investing in Bonds

If you read an intermediate level finance textbook, you will encounter advice that discusses the relative safety of bonds. Usually, you will encounter information that says something to the effect of—national governments have the safest debt obligations, then state and/or local governments, then large businesses, and then small businesses. Those notions may be useful as vague generalities, but provide little insight when you are actually trying to determine how to invest your money: What are the exceptions? How can you tell when, say, a high-quality large business is giving you a “safer” bond offering than a government entity?

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