Popularity Contest?

Picture yourself as a high school senior. At the school’s graduation ceremony, the homecoming king and queen are announcing the ten most popular students as voted by the student body. Do you have a clear picture of the group standing on the stage?

How would you expect these students to have performed financially after everyone gathers at the school’s ten-year reunion? Certainly, some of these students would have continued their winning ways as most of the group were heading in the right direction with their excellent social skills, wealthy parents, and amazing smiles. Yet, I’m guessing you are not expecting great things to happen with the group you’re picturing over the following ten years. Hmmm…

Every day, the stock market is very much like a popularity contest. Liked stocks are “voted” to the top of the list and hated stocks do the opposite. Currently, Apple is the largest (most popular) company in the world because it’s receiving the most votes from the investment community.

Let’s look at the stocks that were the most popular ten years ago. (August 2008 was in the middle of the global financial crisis, The Dark Knight topped the movie charts, and Coldplay led the pop charts.) How did these stocks perform over the last ten years? Have they outperformed or underperformed the basic index fund? Did any keep their top 10 ranking?

These companies were the darlings of 2008 – the ones expected to do bigger and better things, the ones with the social skills, wealthy parents, and amazing smiles. Despite this, only two of these stocks outperformed the basic S&P 500 index’s 10.6% return over the same period. Only three of the ten remain in the popular crowd today.

Is this an oddball, standout period? Unfortunately, no. There is constant turnover in this top 10 list. Only five of the top ten stocks in 1998 stayed in the top by 2008. Only four of the top ten in 1988 were in the 1998 list. Remember, every company is working to make it to the top of the heap, so staying ahead is very difficult.

Who Is winning the popularity contest today?
There is no way to know which of these stocks will continue to lead the pack over the next ten years, but the odds are good that this list will be disrupted, new leaders will emerge, and several of these companies will fade. As a group, there is a good chance that many of these stocks will underperform the overall stock market. I own the S&P 500 index fund in client accounts as it will capture the performance of the winners as well as the next leaders.

To get back to my analogy… I’m betting on the financial success of the entire senior class (the S&P 500 index fund) rather than on the most popular of the day (the individual holdings above). If history is any guide, this will be the best strategy.

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