If you’re a typical investor, you own at least a few individual stocks. If you work for a public company, you probably own some stock in it.

When we counsel new clients, we see this all the time – especially heavy ownership of big Seattle-area companies such as Boeing, Microsoft, Washington Mutual and Starbucks.

Many investors tend to “fall in love” with a stock, especially if past performance has led them to believe they can “trust” it. But this is a logical trap. Who you need to trust is not a company, but other investors; they determine the stock price.

I must admit I’ve fallen into this trap myself. I own a few hundred shares of stock in a big company that I admire. This stock makes up about 10 percent of my otherwise-diversified portfolio – and no, I am not going to identify it.

The statistical odds are that someday I will regret the arrogance of owning this much stock in one company. I don’t think many people are smart enough to reliably pick out tomorrow’s winners – and I don’t think I’m one of the exceptions.

A handful of stocks have done reasonably well over the past year, but how many people do you know who identified them in the spring of 2002 and invested in them?

Picking stocks of excellent companies seems easy. But it’s not. Just two years ago, Enron was almost universally admired. Now it’s a total wreck, having betrayed its shareholders and employees.

People pick stocks for their past performance, assuming the future will be like the past. Usually they are wrong. Microsoft Corp. was a terrific stock to own in the first dozen years it was public. When I was a business reporter at the Seattle Times, I once reported that nobody who had ever held Microsoft stock for three full years could have lost money – and most would have at least doubled their money by holding three years.

What I wrote was accurate. What I couldn’t know was the future. The stock peaked in December 1999; now it’s about 44 percent of that high price. So much for the notion that performance persists.

Forbes magazine in 1917 published its first list of the 100 largest U.S. corporations. In 1987, the magazine looked back and found that 61 of those companies had ceased to exist – and only 18 were still among the 100 biggest companies.

Much worse from an investor’s perspective, from 1917 to 1987, only two of those 18 companies outperformed the stock market: General Electric and Eastman Kodak.

Attrition is the norm. According to a book called “Creative Destruction,” published in 2001, only 74 of the original 500 stocks in the Standard & Poor's 500 Index in 1957 remained on the list in 1997. And only 12 of those survivors had outperformed the index. If you’re a stock picker, those are the odds you are up against. Can you pick the best 12 stocks in the S&P 500?

In the end, stock indexes automatically weed out old, weak companies and attract new, strong ones. Individual investors get in too late and hang on too long.

I know I’m foolish to think I might beat the odds. But I’m smart enough to limit this endeavor to 10 percent of my portfolio. Let’s hope you are at least as smart as that.

 

 

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