Single Stock Portfolios and “My Friend is Beating Me”

Michael Batnick wrote a great post this week about a reader with a friend who invested his entire brokerage account in a single stock (Facebook). It’s hard to argue with an investment strategy when someone shows you eye-popping returns in their personal account. Although you know about the importance of diversification and the benefits of index funds, hearing this type of story can cause jealousy, a fear of missing out (FOMO), and the thought “if my friend did it, there’s no reason I can’t do it too.”

As Batnick points out, one of the major problems with holding a portfolio of volatile stocks is the emotional swing. Huge drawdowns scare investors into selling when they should be buying. Rapid gains entice people to buy more shares when they should be trimming an oversized position. So even if a stock performs well over time, the investor’s emotional mistakes eat away at their returns.

If someone asked me if they should hold individual stocks, I’d ask them a few questions. First, I would ask them how they handle volatility. Have drawdowns ever caused them to sell their stocks or go against their long-term plan? If that’s the case, I would encourage them to take a hands-off approach.
Second, I’d ask what they like about the company they want to invest in. If someone loves reading about business and can speak passionately about capital allocation, brand, long-term strategy, or return on equity, I think they’re fine investing some percentage of their portfolio in the stocks of companies they believe in. Engagement and interest will lead them to save and invest more.

My friend did it, so why can’t I?

There’s another point I’d make to someone who hears about a friend’s amazing single stock returns. Their friend may have picked a good stock, but that doesn’t mean they’re a good stock picker.

Let me explain. There is a fundamental principle in forecasting: a prediction’s apparent “success” doesn’t prove it was a good prediction. This idea is counterintuitive, and is one of the most common misconceptions in probability.

Imagine I said there is a 95% chance the New England Patriots will win the Super Bowl next year. Vegas oddsmakers would laugh in my face. There are 31 other NFL teams who follow the same rules. Even though some teams are better than others, forecasting that any individual team has a 95% chance of winning the Super Bowl would be crazy.

But what if the Patriots did end up winning the Super Bowl? Was my initial forecast of 95% proven “correct” given the outcome? No, because the ex-ante probability of an event is separate from the outcome. If you replayed the season 1,000 times, the Patriots wouldn’t have won 950 Super Bowls.

Skilled, Lucky (Photo Courtesy: United Artists)

Similarly, if I claimed “I have a 100% chance of rolling a six on this dice roll,” and then I happen to roll a six, that doesn’t prove me right. It proves me lucky.

It’s important to remember this point when judging an investor: don’t assume someone is a great stock picker based on a sample size of one. With a sample of one, the best you can do is decide if their stock pick made sense at the time, before they knew the outcome.

So Michael Batnick is right, there are plenty of pitfalls investing in a single stock, even one that performs well over time. Excessive volatility triggers emotional decisions, and emotional decisions are usually mistakes.

But you should also not assume your friend is the next Peter Lynch because they got a great return on a one stock. More information is needed.

Pulling Teeth: The FANG Year and Financial Memes

After reading Michael Batnick’s excellent posts about the distribution of stock market returns (read The Skew and The Other Side), I was inspired to look back at the market of 2015.

Perhaps you’ve heard about 2015, the fabled year when the four “FANG” stocks (Facebook, Amazon, Netflix, and Google) accounted for all of the gains (!) of the S&P 500. Many articles and blog posts were written about this phenomenon in 2015, and the “FANG year” became something of a meme in financial discourse. The S&P 500 returned only +1.4%, but the four FANG stocks returned +34%, +118%, +134%, and +46%, respectively. They accounted for the all of the gains (!) of the S&P. Crazy, right?

Will Deener of the Dallas Morning News wrote, “One of the hallmarks of a healthy bull market is that a broad swath of stocks and sectors move higher in tandem. Currently, that is not the case, with both the S&P 500 and Nasdaq being propped up by only four stocks.”

Only four stocks!

Many people surmised that investors who missed out on the FANG stocks must have had a dismal year. If you picked a random stock from the S&P 500, you would almost certainly not pick a FANG stock, so you must have had a terrible year, right?

Let’s look at the numbers. If you had thrown darts at a board to pick one random stock out of the S&P 500 and held it for the entire year, what were your chances of picking one that outperformed the index?


Yes, 47% of stocks in the S&P 500 outperformed the index that year. So slightly less than half. But still, almost half. You would have had a 47% chance to outperform the S&P 500 just by picking any stock at random and holding it for the year.

What were your chances of selecting a stock that had a positive return?

50.37%. You would have had better-than-even odds of a positive return by picking any stock at random that year.

Let’s look at the distribution of returns in the S&P 500 in a histogram:

The above chart shows the number of stocks that had a 2015 total return at various minimum ranges. The best performing stock (Netflix) returned +134.38%, and the worst (Chesapeake Energy) returned -76.76%. How did the rest do?

  • 50% of stocks returned at least +0.13%.
  • 40% of stocks returned at least +3.83%.
  • 30% of stocks returned at least +10.09%.

So in the infamous “FANG year,” when supposedly all of the gains (!) in the S&P 500 went to just four stocks, 30% of stocks in the index actually returned over +10%.

So what’s going on here? Why was this meme so misleading?

The S&P 500 is market cap-weighted (companies are weighted by their market value). A stock’s weight times its return equals its contribution. Bigger companies have a larger weight, so they can have a larger impact on the index’s return. In 2015, some of the best-performing stocks also happened to have some of the heaviest weights in the index. So it’s true that if you owned the S&P 500 index except for those four stocks, your +1.4% gain would be gone. These four stocks had a combined contribution of almost +2%.

In any given year, the index includes positive contributors and negative contributors. If you took all the stocks with gains in 2015, their combined contribution was +8.9%. This is the gross contribution, or what most people would consider all of the gains. If you took all of the stocks with losses, their combined contribution was -7.4%. This is all of the losses.

When you put the gains and losses together, it was a fairly flat year for the market. The net of all gains in the S&P 500 was just +1.4%. But wait, commentators said, the contribution of the four FANG stocks was more than +1.4%. So voilà, just those four stocks accounted for all of the gains (!).

Naturally, when gains and losses net close to zero it becomes easy to pick out a small group of stocks whose contributions add up to the net market return. What’s more, the FANG stocks weren’t even the top four contributors that year. Amazon was number one, but Microsoft was number two and G.E. was number four. Saying only the FANG stocks mattered in 2015 is like saying the only reason a football team won 28-21 is one particular touchdown. Every point counts.

All this FANG talk gave many people the false impression that only four stocks had any gains at all that year. But there were plenty of other stocks with huge returns that year. NVIDIA returned +67%. Hormel foods returned +54%. Starbucks returned +48%. Kroger returned +32%.

Nevertheless, the “FANG year” meme had spread across financial media like World War Z. ‪It’s a fun idea, but not all that meaningful.