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Past Performance Means What?

George L Smyth

This week, I will appear to contradict the information that I offered the previous two weeks. (Both past articles are linked to the right of this text.) However, it will depend upon how one decides to interpret the following information as to whether or not this column supports or contradicts recent columns.

In my past two columns, I provided an argument for giving greater consideration to companies that have  superior long-term past performance, and I argued against giving much weight to current short-term performance. Selecting a company that has offered excellent investment returns for many years gives a level of comfort (and in some forms, reliability) that near-term speculation simply cannot provide.

I decided to test the hypothesis that excellent long-term performance will provide a better-than-average opportunity for continued success in the future. I wanted to see if this could truly be used as an indicator.

I was able to find a listing of the largest companies, as measured by market capitalization, as of March 15, 1996. These large companies are the ones that we generally tend to favor for Drip selections. I decided to look at 25 of these companies to see how they had performed during the previous five years. I did not take dividends into consideration, as I have no idea where to find that information. However, I felt that the information I had obtained would at least get me in the ballpark for questioning my theory.

I compared the percentage stock price increase for each company to the Standard & Poor's 500 Index, which we use as our standard benchmark. With the ability to dollar-cost average into this index through an inexpensive mutual fund (an index fund), if this benchmark cannot be beaten through the choice of equities, this money would do better in the index fund. The dates of the study run from April 1991 through June 2000, the first portion running April 1991 through March 1996, and the second portion running April 1996 through June 2000. The numbers were taken from monthly historical quotes that can be found on Yahoo!.

Of the 25 companies in the study, 18 outperformed the S&P 500 Index's 71.4% return in the 1991 to 1996 time period. According to my theory, these 18 companies would have a better-than-average chance to beat the S&P 500 Index over the long term, starting with 1996 and going through mid-2000. So, I examined the stock prices of each of these 18 companies from March 1996 through June 2000.

These 18 companies averaged an advance of 173.1%, topping the S&P as a whole, with eight beating the S&P 500 Index and 10 not beating it. The companies that beat it averaged a return of 342.4%, while those not beating it averaged 57.5%.

So, how do you interpret these results? Do you look at the fact that the 18 companies together outperformed the index by 2.4 times, or are you taken aback by the fact that more companies on the list underperformed the index than outperformed it during the second time period?

An even more interesting question to consider is what percentage of large capitalization companies normally outperforms the S&P 500 index, anyway?  I know of no source for answering this question. (Do you?)

Of course, the best strategy would be to look at this data over a period of 40 to 50 years. Again, unfortunately, the numbers are not available to me, so there is no way to know.