Netflix is an impressing stock. Despite some recent turbulence, its returns make even its FANG (Facebook, Amazon, Netflix, and Google parent Alphabet) counterparts pale in comparison — a 10-year annualized return of 59% (that’s more than 10,000% cumulative)! All the FANG (or FAANG or FAAMNG) names have been remarkable for investors; although, it’s unlikely many have weathered the volatility. Each FANG stock has had a drawdown of more than 60% (except Facebook, which went public most recently and has only had a 40% drawdown so far), with three members experiencing peak-to-trough declines of 80% or more. But despite those large drawdowns, investors are attracted to the allure of picking a lottery stock or two and sailing off into the sunset.
Without the benefit of hindsight, how realistic is investing in a Netflix, say 10 years ago, and holding that stock until today? In investing, time is very much your friend. It’s often shown that over long periods, say 10 years or more, stocks are positive an overwhelming majority of the time, which is true and great! But that analysis is typically based on broadly diversified index returns. Choosing a less diversified group of individual stocks can become more challenging than many think, even with time on the side of investors.
The chart below shows the percentage of stocks that outperformed the broad index, underperformed, or are no longer trading over the time frames shown below. Stocks could no longer be trading for a variety of reasons — merger or acquisition (likely good for investors), index delisting, or bankruptcy (likely bad for investors).
Over the last five years, less than 30% of all stocks available five years ago have outperformed the index as of June 30, 2018. That means 47% have underperformed and an amazing 24% are no longer trading. The shrinking number of U.S.-listed stocks seems to be shrinking faster. Over the last 10 years, the number of underperformers jumped to more than 60%. Back two decades, the number of stocks no longer trading really jumps out, and the percentage that outperformed was a measly 15%.
If we haven’t realized it yet, picking stocks is not an easy task. It’s especially tough to predict the big winners (less than 5% of stocks beat the index by more than 5% over 20 years). So, what is the remedy? Diversification, of course! Owning, say, a U.S. stock ETF increases your chances for outperformance — and, maybe better yet, reduces your chances for underperformance dramatically. As the chart below shows, the range of returns tightens and skews positive for ETFs versus individual stocks. For U.S. stocks, it’s also important to mention the chart shows only the range for surviving stock returns.
The ETF universe was dramatically smaller 20 years ago, but the idea of diversifying to reduce your risk of ruin still prevails. ETFs catch criticism for distorting prices, or for being a less-proper way to invest overall. Did I mention that despite the incredible returns, ETFs only own 6% of Netflix shares? Sophisticated investors need to accept that ETFs are here to stay and embrace their functionality and efficiency. Individual investors should realize that time is dramatically on their side, but picking stocks may prove to be a tougher road than they think. Deciding on what to watch on Netflix is a tough task, but it is nothing compared to picking stocks!
Grant Engelbart, CFA, CAIA, is a Portfolio Manager at CLS Investments, a participant in the ETF Strategist Channel.
Disclosure Information
The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change. No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed here and should understand that statements regarding fu¬ture prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies. The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a guide to investing. 1752-CLS-7/31/2018.