Why Stock Picking Is So Hard
/By Shelley Murasko
Over two-thirds of mutual fund managers actively researching and picking stocks fail to beat the broad S&P 500® Index in any given year. Is this because financial managers are idiots and need to go back to MBA school?
Most likely, no. The fact is that it’s nearly impossible to consistently pick individual companies that will beat the performance of the stock market. As the following examples show, predicting the next stock winner is an exceedingly difficult task.
More Important Than the Internet
In 1999, an American company launched a product that was expected to sweep the world by storm. Apple co-founder Steve Jobs called it “the most amazing piece of technology since the personal computer” and offered $63 million to back the company.
Jeff Bezos, the founder of Amazon.com, said the “product was so revolutionary, you’ll have no problem selling it.”
John Doerr, the world’s most successful venture capitalist, pumped $80 million into it and bet it would be the fastest company to reach $1 billion in sales. He also predicted that it “would become more important than the internet.”
The inventor of this product, Dean Kamen, was described as a modern Thomas Edison. He already had a track record of remarkable breakthroughs, including a portable dialysis machine and a portable drug-infusion pump. Kamen stated that the product “will be to the car what the car was to the horse and buggy.”
Unfortunately, all these expectations were wrong. The Segway®, a two-wheeled personal transporter, limped along for about fifteen years but never reached the predicted level of success. Production was ultimately ceased in July 2020 when the 21 employees working at the Bedford, New Hampshire, plant were laid off.4
Disney’s Folly
In 1934, cartoonist Walt Disney became dissatisfied with producing cartoon shorts. He believed that a feature-length cartoon would be more profitable. When news leaked out about the making of his debut film, Snow White and the Seven Dwarfs, most in the film industry predicted the company would go bankrupt. They referred to it as “Disney’s Folly.”1 Even Disney’s wife said that no one would pay a dime to see animated dwarfs for 80 minutes.2
During production Disney faced many challenges, including limited technology that made it hard for animators to draw human characters in a way that would elicit emotion. The film cost $1.5 million to produce, which was three times over budget. Disney eventually had to mortgage his house to help finance the film’s production. All told, Snow White required the work of 750 artists, 32 animators, 25 background artists, 102 assistants, and the creation of thousands of drawings.3
“It was prophesied that nobody would sit through such a thing,” Disney said. “But there was only one way we could do it successfully, and that was to plunge ahead and go for broke: shoot the works. There could be no compromising on money, talent, or time, and this was at a time when the whole country was in the midst of a crippling depression.”3
Snow White and the Seven Dwarfs was clearly a project that could have finished Disney for good. Instead, it went on to change cinema. The film premiered to rave reviews on December 21, 1937. Snow White won numerous awards, including an Oscar for Disney. Today, it ranks among the top ten most profitable films of all time.
The Difficulty of Predicting the Next Microsoft®
As it turns out, it’s incredibly difficult to predict how a new product or service will evolve over its life cycle. There are simply too many factors needed for an accurate forecast, including competition, market demand, regulatory landscape, supply chain challenges, employee retention, and company leadership.
When selecting a stock, you’re picking a company you partially own to make money on the organization’s profits and growth. Thus, the key to picking a winning stock is successfully predicting how the company’s ideas are going to pan out over time.
As demonstrated above, knowing how a new product or service will unfold is nearly impossible even for the experts.
In addition, picking these great ideas can result in hefty spending on research and taxes. Doing so could greatly erode return, making it hard to outpace the low-cost index fund that owns the whole basket of stocks.
What’s an Investor to Do?
One option is to avoid individual stock picking with your “serious” money: the funds you’re counting on for retirement, sending kids to college, or funding your kitchen remodel. Instead, invest in a broad-market, low-cost index fund that not only puts you on the path to stock market returns but also gives you a much greater degree of reliability for achieving your financial goals.
If you decide to give stock picking a try, carve out no more than 10% of your investment dollars. Measure your performance versus an index, then assess whether it’s worth the time and effort.
Long story short is that, except in very rare occasions, no one is knowledgeable enough to reliably beat the market over an extended period with individual stock picking. When life goals require certain returns, choosing an inexpensive, well-diversified fund is likely going to deliver you more dependable results as you head toward your desired future.
Sources:
1. Wikipedia contributors. “Walt Disney.” Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Walt_Disney.
2. The Daily Coach staff. “Walt Disney’s Unique Vision.” The Daily Coach. Retrieved from https://www.thedaily.coach/p/walt-disneys-unique-vision.
3. Lambie, Ryan. (Feb. 8, 2019). “Disney’s Snow White: The Risk That Changed Filmmaking Forever.” Den of Geek. Retrieved from https://www.denofgeek.com/movies/disneys-snow-white-the-risk-that-changed-filmmaking-forever.
4. Wikipedia contributors. “Segway Inc.” Wikipedia. Retrieved from
5. https://en.wikipedia.org/wiki/Segway_Inc.#:~:text=Independent%20years-,Segway%20Inc.,to%20customers%20in%20early%202002.
Risks
This article is being shared for educational purposes and should not be misconstrued as direct financial advice. Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Diversification does not eliminate the risk of market loss.
