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Duncan Lamont is head of strategic research at Schroders.
In 13 of the past 18 years, not a single US stock that was a top-ten performer in one year also made the top ten in the next. In four of the other five years, only one managed the feat. In the other, a barely better three did.
Even staying in the top 100 is rare. An average of 15 companies per year managed to be in the top 100 for two consecutive years.
The odds of a repeat appearance in the top ten or top 100 two or three years down the line are similarly low.
It’s not even that they still do well but drop back from the glory stakes. In 14 of those 18 years, top-ten performers dropped to the bottom half of the performance rankings in the next year, on average. They were more likely to be among the worst-performing stocks than the better ones.
The typical drop in ranking has been savage.
Similar trends exist in other markets. In both Japan and the UK, in 11 out of 18 years, top-ten performers fell to the bottom half of the performance distribution in the next year. In Germany, it happened in all but four of the last 18 years.
It’s human nature to back winners. Hype is exciting! That’s why value investing is so psychologically hard to do in practice. It involves buying the losers, the unloved stocks.
More generally, the charts above show why investors should be cautious about chasing performance. Strong gains will tend to stretch valuations relative to fundamentals like earnings. Share prices start to bake in ever more optimistic expectations. At one point, Tesla traded on a valuation of over 200 times consensus forecasts for its next 12-months’ earnings (today it is on 77x). The erstwhile Magnificent-7 collectively are twice as expensive as the rest of the market, in terms of a multiple of next-12 months’ earnings.
Some companies may be able to deliver on these expectations (identifying which is the hard part). Many will not. And it can only take a small miss on earnings or a small change in the external environment – as happened this month – for an outsized share price reaction from the “hot stocks”.
The companies that win in the long run are often not the ones that are the best performers in any one year but the ones that can grow sustainably in the long run. Several years of good results and performance can easily compound over time to deliver better investment returns, in a less helter-skelter way, than if you are tempted to chase the best performers.
Momentum has been a popular investment strategy in recent years, but naively glory hunting is likely to result in high costs and mediocre returns. Don’t believe the hype.
