The art of investing – finding and keeping the winners
We recently published a blog post here showing that all of Berkshire Hathaway’s alpha between 2016 and 2023 came from just one stock – Apple. Without Apple, Berkshire would have underperformed the S&P 500.
I know firsthand how challenging it can be to invest in equities. Pursuing exceptional returns requires the ability to identify rare out-performers and the discipline to hold them through inevitable market turbulence.
The data, however, paints a sobering picture: selecting winning stocks is a formidable task, and maintaining conviction over the long term is even more demanding. There is a practical strategy inspired by one of the world’s foremost valuation experts, Aswath Damodaran, that offers a balanced approach once you’ve identified a winner but before that, let’s examine the problem.
The stark reality of stock market returns
The stock market is often celebrated for its wealth-creating potential, but the reality is far more nuanced. Research by Professor Hendrik Bessembinder, detailed in his 2018 study Do Stocks Outperform Treasury Bills?, reveals a striking truth: the vast majority of stocks fail to deliver meaningful returns. Analysing 26,000 U.S. companies from 1926 to 2016, Bessembinder found that just four per cent – approximately 1,000 stocks –accounted for the entire US$35 trillion in net shareholder wealth created above U.S. Treasury Bills. Even more remarkably, the top 90 firms, a mere 0.33 per cent of the total, drove half of this wealth. For the remaining 96 per cent of companies, the most common outcome over a decade was a complete loss (the remainder were mergers and takeovers).
Bessembinder’s methodology was deceptively simple and he concluded, “Most stocks are not doing well for investors,” adding, “but a few deliver very large compound returns.” This skewness over the very long term – the extreme concentration of gains in a handful of stocks – defines the market’s non-ergodic nature, where outcomes are neither predictable nor evenly distributed.
The global perspective is equally striking. In a follow-up study covering 64,000 companies across 43 countries from 1990 to 2020, Bessembinder found that just two per cent of firms generated the entire US$76 trillion in net wealth creation. The top five companies alone contributed over 10 per cent, while 98 per cent of firms either matched or underperformed risk-free assets. These findings, shared at the Active Advantage conference in Sydney, reveals the U.S. market’s asymmetry is not unique.
Research by John Rekenthaler, examining the 5,000 largest U.S. stocks from 2011 to 2020 – a decade marked by a near-unrelenting bull market – also revealed the challenges of selecting outperformers. His findings showed that only 42 per cent of these companies posted gains, with a mere 20 per cent surpassing the broader market index. Meanwhile, 36 per cent declined in value, and 22 per cent ceased to exist, either through acquisitions or delistings.
These numbers underscore a stark truth: the odds of picking a stock that consistently beats the market are slim, with long-term probabilities falling below 10 per cent. Yet, for those rare instances when you identify a true winner, the data suggests a clear imperative – holding for the long term is far more rewarding than cashing out prematurely. This insight emphasizes the need for disciplined conviction, as capturing the full potential of high-performing stocks requires patience and a tolerance for market fluctuations.
Why is outperformance so elusive?
The market’s lopsided returns stem from its inherent unpredictability. Unlike a coin toss, where outcomes are roughly balanced, stock performance hinges on rare outliers. Most companies, despite rigorous due diligence from brokers and fund managers, fail to sustainably add value over time. Bessembinder’s analysis of U.S. stocks over 50 years from 1970 to 2020 identified sustained income growth as the primary driver of long-term success. While that factor explained less than 30 per cent of returns, it far outweighed other factors like asset or sales growth. Yet, identifying firms with this potential early (ex-ante) is a daunting challenge.
The psychological barrier of holding winners
Most investors don’t expect to hold a stock for 50 years, so the research has some limitations from a practical perspective. Nevertheless, for those who do select a winning stock, the greater test is maintaining conviction for long enough to accrue transformative gains. Market volatility, economic shifts, Trump and the temptation to lock in early gains can derail even the most disciplined investor.
Consider the hypothetical case of an investor who allocated $10,000 to a high-growth technology firm in 2025. By 2027, the investment doubles to $20,000. The urge to sell and secure a profit is powerful, but selling too soon could mean missing out on exponential growth. By 2035, the position could be worth two million dollars or more. And those gains will be needed if the statistics on the remaining stocks prove reliable.
The emotional discipline required to hold through such cycles is what separates modest gains from transformative wealth.
A surprising strategy: sell half, retain half
This is where Aswath Damodaran’s strategy might help. A globally respected authority, lecturer and author on valuation, Damodaran advocates a balanced approach: when a stock appreciates sufficiently (100 per cent), sell 50 per cent to recoup your initial capital and let the remaining shares continue to grow. This pragmatic method isn’t perfect and it’s a surprisingly simplistic one coming from the highly-regarded Damodaran, but it achieves two critical objectives. First, it locks in tangible gains, reducing the risk of regret if the stock later declines. Second, it keeps you invested in the company’s long-term potential, capturing the compounding effect that drives the market’s outsized returns.
The strategy also arguably aligns with the market’s skewed dynamics. It acknowledges the difficulty of picking massive wealth compounders while providing a structured way to manage risk. By selling half, you create a psychological buffer, allowing you to view the retained portion as a low-risk opportunity. This approach is not about maximising every dollar but about sustaining confidence and staying in the game for the rare, wealth-defining winners.
Bessembinder’s research suggests active investing requires rigorous analysis to identify companies with strong fundamentals, particularly those with durable profit growth. For those with the patience and the expertise – or access to skilled managers – the rewards can be substantial. As Buffett’s investment in Apple demonstrated, a single exceptional investment can offset multiple underperformers.
Rather than viewing equities as a balanced bet, consider that a few deliver extraordinary results. For sophisticated investors, the key is to blend analytical rigour with emotional discipline. Once sufficient gains are accrued, Damodaran’s simple suggestion allows you to secure gains while remaining positioned for the rare but transformative opportunity.
In a volatile world where only a handful of companies create lasting wealth, this balanced response might just be a useful tool for building and maintaining a resilient and rewarding equity portfolio.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
