The Risks and Rewards of a Concentrated Stock Position – ValueWalk Premium
Concentrated Stock Position

The Risks and Rewards of a Concentrated Stock Position

The Risks and Rewards of a Concentrated Stock Position

Executive Summary

There are many Horatio Alger stories in the corporate world in which an entrepreneur or CEO has the right idea at the right time and executes brilliantly on a business plan. But history also shows that forces both within and outside management control led many of their businesses to suffer serious reversals of fortune. As a result, many individuals are known not just for the wealth they created through a concentrated stock position, but also for the decision they made to sell, hedge or otherwise take some chips off the table. In this paper, we take a look at the long history of individual stocks, and at the risks and rewards of concentration. I first analyzed this topic in detail around ten years ago; since that time, while some things have changed, the overall song remains the same.

Over the long run, some companies substantially outperform the broad market and maintain their value. However, the odds have been stacked against the average concentrated holder:

  • Risk of permanent impairment. Using a universe of Russell 3000 companies since 1980, roughly 40% of all stocks have suffered a permanent 70%+ decline from their peak value. For Technology, Biotech and Metals & Mining, the numbers were considerably higher.
  • Negative lifetime returns vs. the broad market. The return on the median stock since its inception vs. an investment in the Russell 3000 Index was -54%. Two-thirds of all stocks underperformed vs. the Russell 3000 Index, and for 40% of all stocks, their absolute returns were negative.
  • After incorporating the issue of single stock volatility, we find that 75% of all concentrated stockholders would have benefited from some amount of diversification.

Another sobering observation: since 1980, over 320 companies were deleted from the S&P 500 for business distress reasons, which implies a lot of turnover. This should not be a surprise: capitalism is based on competition, creative destruction and reinvention. While globalization (and in particular, China’s acceptance into the World Trade Organization in 2001) expanded the opportunities for individual companies, it also increased their competitive, regulatory and operational risks.

We start with some empirical analysis, and follow with case studies by sector. While the losses on the stocks in our case studies may seem obvious or inevitable with the benefit of hindsight, in all likelihood the company’s management, its board of directors, research analysts, credit rating agencies and its employees all firmly believed in its long-term success.

Concentrated Stock Position: The steady drumbeat of creative destruction in the S&P 500

A simple place to start when thinking about the risk of concentrated stock positions: how often do their circumstances change? Since 1957, the S&P 500 has served as a proxy for 500 of the largest, most successful US-domiciled companies. We have compiled a detailed history of its additions and deletions since 1980, which forms the basis for this part of the analysis. To be clear, not every S&P 500 deletion was the result of a “problem stock”. Actually, most deleted companies were not the result of a problem, and reflect benign index removals because: they were acquired at a premium to their current price; they merged with other companies in the index; or, they reincorporated outside the US.

After sorting through the benign deletions, we focused on the rest: the S&P 500 deletions that were a consequence of stocks that failed outright, were removed due to substantial declines in their market value, or were acquired after suffering such a decline. As shown below, there were over 320 of them since 1980. The pace of distress-based deletions rises during a market crisis or recession, but there is a steady pulse of business failure during the entire business cycle. Consumer Discretionary, Technology and Financials accounted for the majority of distress-based deletions.

Concentrated Stock Position

See full The Risks and Rewards of a Concentrated Stock Position in PDF format here.


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