Do Stocks Outperform Treasury Bills? - Bessembinder's Report

….The results here show that the returns to active stock selection can be very large. If the investor is either fortunate or skilled enough to select stocks that go on to earn extreme positive returns.  Of course, the key question of whether an investor can reliably identify such “home run” stocks, or can identify a manager with the skill to do so, remains.

A large number of academic studies on common stocks concentrate on maximizing total return in excess of the market. This is all good and can be quite beneficial.  But when a person’s needs change from maximizing total return to the preservation of wealth, a different approach is required. 

Preservation of wealth does not mean the absence of risk. In fact, it requires a return in excess of price changes (inflation) over time. If cash flow is needed from a portfolio, an approach that has some possibility that the earned rate of return will exceed the cash flow needs, costs, taxes, and inflation is worth pursuing. A difficult, if not impossible task! But by knowing the minimum required rate of return needed to preserve wealth, we can build and maintain a portfolio that increases or reduces risk based on the potential impact to our current state of wealth. A bit more practical than “beating the market.”

The universe of companies that we select from for the inclusion in a portfolio have these characteristics:

  • A large market value actively traded on a recognized exchange
  • A large amount of revenues
  • A low level of debt relative to equity
  • Positive cash flow
  • Pay a dividend
  • A current price less than our estimate of fair value

A little common sense went into the universe selection process. The larger a company, the easier it is to monitor, so if a problem develops we will know almost immediately. A large revenue base assures us that we can place some value on the business itself and rely less on the dreams of what could happen. Low debt and positive cash flow are easy to understand; owning more than you owe, and having more cash coming in than going out, makes it pretty hard to go bankrupt. Finally, a dividend provides some cash flow to meet our individual obligations, or provides an opportunity to diversify if we so choose.

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Disclosure: Anderson Griggs & Company, Inc., doing business as Anderson Griggs Investments, is a registered investment adviser.  Anderson Griggs only conducts business in states and ...

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