It’s a popular question among some personal finance enthusiasts: is it better to invest in index funds or individual stocks? There can be evidence pointing in multiple directions, though it’s become more popular of late to focus on index funds.
Personally, I’ve been leaning that way. My approach has evolved to having index funds as a foundation for stock investing, with some opportunistic purchases along the way, based on market events and historical anomalies. With respect to the latter, regular readers of Squirrelers have seen period analysis I’ve done with provides reasoning for occasionally making such purchases. Just to point to 2 examples, analyses done on stock market returns by month as well as market reactions to the japan tsunami disaster can show how there are times where there truly are opportunities to jump in.
That being said, as I mentioned up front, I’ve been liking index funds – and regular investments in them whether large or small. With that in mind, I set out to do an analysis of comparing individual stocks from “best company” lists to the S&P 500.
Hypothesis – Phase I
My original hypothesis was that if you looked at a list of so-called top companies, or best companies, etc – you’d find that they probably don’t do much better than the S&P 500 as a whole in terms of stock returns. Therefore, if you invested in an index fund with low turnover and low expenses, you would do better than you would with more active trades or just buying a bunch of individual stocks. In this case, I’m basing this on changes in stock price.
Methodology – Phase I
The steps I decided to take involved looking at a list of top companies, as I alluded to earlier, and comparing stock performance to broader markets as a whole. In order to do that, I searched for top companies, and located a list of Business Week’s top global companies. I chose the 2009 list of top 40 companies, as that would give me 2 years of data afterward for which I could use in my comparison.
The article was dated October 1 of that year, so ended up selecting October 2009 through September 2011 as my 2 year analysis period. Additionally, in looking at the 40 companies in the list, I actually included the ones that were publicly traded on U.S. exchanges. This meant that the analysis consisted of 14 companies.
What I did was to take the 14 companies and calculate the change in stock price during that 2 year period for each one. Additionally, I did the same thing for the S&P 500 during that time period. Then, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.
Results – Phase I
Here are the findings:
As I looked at the results, it appeared that the hypothesis did not turn out to be correct. Interesting.
Rather, it looked like the basket of analyzed companies from the 2009 best company list significantly outperformed the S&P 500. In fact, the increase in stock prices over that time period was 28% for the best companies, versus 10% for the broader market basket. Now, if you look at the list, there were two clear outliers: Amazon and Apple. Fair enough. However, even when those 2 companies are removed from the analysis, the remaining 12 still have a 12% increase, which outpaces the 10% of the broader market.
Well, then. So much for the idea that an index would be better than some list of best companies!
Hypothesis – Phase II
After taking a look at the preceding analysis based on the aforementioned best companies list, I thought it might be worth it to try again with a different list of companies. Maybe then we could see if we got a different result. I didn’t originally plan to look at another list, but this “Phase II” seemed like a good idea to continue this line of thought. Again, recall my original thought that index funds would perform just as well.
Methodology – Phase II
In this second scenario, I examined the list of Fortune’s best companies to work for, also from 2009 to keep things consistent with the prior analysis. Here, the date noted was February 2009, so I used data from February 2009 through January 2011. In this case, I went from the top of the list down, and selected companies that were publicly traded. Additionally, I chose 14 companies in order to align with the assessment of the Business Week list, and chose the highest ranking ones starting from the top.
As I did previously, I took this set of companies and calculated the change in stock price during that 2 year period for each one while doing the same thing for the S&P 500 during that time period. Once again, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.
Results – Phase II
Here are the findings:
First of all, this was a period of an extraordinary rebound in the market. That’s evident in the 56% return in the S&P during this 2 year time period. Granted, most people saw their portfolios tumble in value prior to that time period, so this was a market recovery in some ways.
That being said, the performance of the top 14 traded companies on the list of best companies to work for showed a 140% increase in stock price, easily exceeding the 56% gain of the S&P 500 during that time.
This second list had only one company in common with the first one: Google. The rest of the companies were different.
Putting it all together, it appears that the hypothesis that index funds could match “best company” list performance didn’t find it’s way into the results. Rather, the best company lists outperformed the market average by a broad margin.
Now, I suppose that there could be other lists that under perform the market. If those were viewed in a stand alone analysis, we might be having an entirely different conversation. So, we can’t jump to any conclusions that such lists always outperform the market. I doubt that would happen, as rule anyway.
However, it does lend some credence to the notion that perhaps there are some types of companies that just do perform better than others, based on pre-defined criteria. Maybe the reality that these were companies that were perceived to be well-run and/or good employers is indicative of their potential to beat expectations and increase in value?
My Questions for You
What do you think of the idea that investing in companies that are regarding as well-run and great employers can help yield better returns than investing in the broader market?
What criteria do you use to evaluate companies in which you might invest?
Where do you stand on the issue I brought up in the first two paragraphs, where I expressed the view that index fund investing is a great primary foundation, with other investments made only made opportunistically?