Today’s high-flying stocks are rarely tomorrow’s. Research shows you lose when you chase past performance
Yesterday’s home runs don’t win today’s games. Keep this classic truth from Babe Ruth in mind when you hear the market chatter about the “Magnificent Seven” stocks.
These are the seven high-flying tech mega-companies that have investors and commentators abuzz lately: NVIDIA, Microsoft, Apple, Alphabet (Google), Amazon, Meta (Facebook) and Tesla.
The Mag 7, as they’re sometimes called, performed exceptionally in 2023, ranging from a 48% gain for Apple to an astonishing 239% for NVIDIA. As a group, these seven giants returned 75.7% last year, more than triple the 24.2% gain of the S&P 500. As of mid-June, the Mag 7 made up 28.8% of the S&P 500 index’s market cap.
(I talk more about the Magnificent Seven in my latest Capital Topics podcast with François Doyon La Rochelle.)
Not a new phenomenon
The seven-star stocks certainly have impressive results, but this is far from being the first time a small handful of darling companies has turned heads or dominated markets. In the late 1990s, the dot-com companies were all the rage. In the 1970s, we had the Nifty Fifty.
The Mag 7 stocks themselves are a successor to the FAANG big tech stocks (Facebook, Amazon, Apple, Netflix and Google), which in turn succeeded the FANG stocks. Today’s stock concentration is also nothing new. In fact, while NVIDIA is 7% of the total U.S. stock-market value, that’s small potatoes compared to AT&T, which was 13% of the market in 1932, the Wall Street Journal reports. In 1928, General Motors was 8% of the market, while in 1970, IBM made up 7%.
High performers underwhelmed
As the examples of AT&T, GM and IBM show, market leaders don’t stay at the top forever. In January, when Amazon became the world’s largest company by market cap, the Wall Street Journal took a look at what happened to the 10 previous companies that held the top spot.
In the five years before they reached No. 1, these companies outperformed the market by an average of 48 percentage points, the newspaper found. But over the five years after they hit No. 1, they underperformed the U.S. stock market by 6 percentage points on average.
It’s like the old maxim says: Past returns are no guarantee of future results. Indeed, if we can be fairly certain of anything, it’s that today’s market heroes are unlikely to be tomorrow’s.
Top 10 no more
In 2000, the top 10 stocks in the S&P 500 included tech giants Microsoft, Intel, Lucent, IBM and Cisco. Today, except for Microsoft, none of these companies or any of the other then-top-10 stocks are in the list. IBM was one of the largest U.S. stocks for over six decades and made up 6.4% of the S&P 500 index in 1985; as of late June, it sits at No. 56 and has a weight of 0.35%.
Another classic example is General Electric (GE). It was in the top 10 for nine decades, but is now No. 48. In fact, Morningstar recently named GE to the top spot in its list of “15 Stocks That Have Destroyed the Most Wealth Over the Past Decade.”
GE’s market cap dropped by $55 billion over the 10-year period ending in 2023, by far the most of any U.S. stock, Morningstar said.
Diversification is key
IBM and GE aren’t unique. A former Yale University finance professor, Antti Petajisto, looked at data going back to 1926. Stocks that were among the top 20% performers over the prior five years had a median market-adjusted return 17.8% lower than the broad equity market during the ensuing 10 years, Petajisto found.
The results suggest it’s a bad idea for investors to hold a high portion of their assets in single stocks, he said. “Concentrated stock positions usually contribute negatively to portfolio returns… The case for diversifying concentrated positions in individual stocks, particularly in recent market winners, is even stronger than most investors realize.”
High-flying stocks come and go
At PWL, we fully agree. This is why we invest in a broadly diversified portfolio using evidence-based strategies. That has allowed us to benefit from the Magnificent Seven’s gains through our ownership of broad index funds. And it also means we’re well positioned to benefit from the next generation of market stars.
At times like these, we like to refer to Warren Buffett’s words of wisdom. In 2018, Buffett was asked by an investor at Berkshire’s annual meeting why he hadn’t bought Microsoft. “We missed a lot in the past, and I suspect we’ll miss a lot more in the future,” Buffett responded.
In other words, high-flying stocks come and go. Swinging wildly for the fences doesn’t win the game. Solid, consistent play over the long run does.
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Find more commentary and insights on personal finance and investing in our past blog posts, eBooks and podcast on the website of PWL Capital’s Parkyn-Doyon La Rochelle team and on our Capital Topics website.