Research has shown no reliable way to predict the top‑performing stocks, arguing for diversification instead.
The stocks commonly referred to by the FAANG moniker— Facebook, Amazon, Apple, Netflix, and Google (now trading as Alphabet)—have posted impressive gains through the years, with all now worth many times their initial-public-offering prices. The start of 2020 is no different. The notion of FAANG stocks as a powerful group holding sway over the markets has sunk its teeth into some investors.
But how much of the market’s recent returns are attributable to these stocks?
And does their performance point to a change in the markets?
Over the 10 years through December 31, 2018, the US broad market (1) returned an annualized 13.4%, as shown in Exhibit 1 below.
Excluding FAANG stocks, the market returned 12.6%. The 0.8-percentage-point bump resulted from the FAANGs collectively averaging a 30.4% yearly return over the decade.
Investors may be surprised to learn that it is actually common for a subset of stocks to drive a sizable portion of the overall market return. Exhibit 2 shows that excluding the top 10% of performers each year from 1942 (2) to 2018 (3) would have reduced global market performance from 7.2% to 2.9%. Further excluding the best 25% of performers would have turned a positive return into a relatively large negative return.
This lesson also applies to capturing the premiums associated with a company’s size and its price-to-book ratio. Research by Eugene Fama and Kenneth French (”Migration,” 2006) provides evidence that these premiums are driven in large part by a subset of stocks migrating across the market.
This post is from Dimensional Fund Advisors.
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