Greater Than the Sum of Its Parts
Here’s something a little counterintuitive.
Suppose you ran 100 randomized trials where for each trial, you picked a random date. From that date, you got a list of all the stocks then existing on that date available to trade in common shares on the NASDAQ or NYSE. And for each stock in that list, you found its all-time worst decline. Here is a visual example of what I mean by “all-time worst decline.” Here is Paypal (PYPL) from IPO to January 1, 2020:
The blue line represents its stock price and the orange line represents the lowest price it has fallen to. PYPL’s “all-time worst decline” would then be the largest percentage difference between the blue and orange line, or specifically, the smallest value from the set of {(orange_i - blue_i) / blue_i} where orange_i and blue_i represent prices on the orange and blue lines at time i respectively.
Doing the math, this comes out to approximately -24.3%. You might be surprised to know that this was when PYPL fell from $40.47 a share on 2015–07–20 down to $30.63 on 2015–09–29, its opening quarter!
You might be thinking, “Hey, what about that gi-normous drop at around day 1400? Ah, my friend, that was by no means insignificant, but not as great. There, PYPL fell approximately -20.3%, from $121.30 per share on 2019–07–24 to $96.64 per share on 2019–10–23.
For each trial, then, we rank the stocks based on their all-time worst declines. We would take the best 30 stocks (those with the smallest declines) and see how they performed over the next year, as a group.
Looking at all 100 trial performances of 30-stock portfolios, the worst performing portfolio fell 41%.
What if we ran another test of 100 randomized trials, using the same trial dates as before, but this time, instead of taking the best 30 stocks ranked by all-time worst declines, we rank stocks by two metrics: (1) all-time worst decline and (2) their age, where older is ranked better. Taking the top 30 stocks based on their average rank of those two metrics, we measure their performance in the following year.
Looking at all 100 trial performances of those 30-stock portfolios, do you think the worst performing portfolio did worse than that of the first 100-trial test or better?
It did better and by a long shot: the worst-performing portfolio where age was taken into account fell only approximately 15.4%.
Is there any reason to suspect older stocks to be better? What if we did the same but instead ranked younger stocks better than older ones? Well, it turns out favoring younger stocks did turn out worse: the worst-performing 30-stock portfolio over 100 trials fell 48.4%.
If we ran the test again but this time only took the 30 oldest stocks without regard to their all-time worst declines, the worst performing portfolio would have fallen 32.9%.
If we ran the test again but this time only took the 30 youngest stocks without regard to their all-time worst declines, the worst performing portfolio would have fallen 51.9%.
What can we conclude from these five trials?
To recap:
All-time worst declines: -41%
All-time worst declines + Age (older better): -15.4%
All-time worst declines + Age (younger better): -48.4%
Age (older better): -32.9%
Age (younger better): -51.9%
Taking into account a stock’s all-time worst declines alone is not an effective measure against future loss and neither is taking a stock’s age alone either, but when taken together, the older stocks win out.
So if you are faced with a decision to choose between an older stock and a younger stock when all else is equal, and you want to minimize the risk of loss, go with the older one.
If you like my content please follow me on all my socials. And if you feel especially ambitious, support me by becoming a patron. It’d really mean a lot.
WARNING: By using or reading my content in any way, you acknowledge and agree to the following: I am not a registered investment adviser nor am I licensed or qualified to provide investment advice. My content is for informational purposes only and is not advice (financial, investment, or otherwise). You should never invest based solely on my content. You should assume my content is not trustworthy unless verified by your own independent research. None of my content is a guarantee that you will make a profit if you use my content. By reading or using my content in any way, you do so entirely at your own risk. I am not nor shall I be liable to you for any damages or losses you incur directly or indirectly as a result of or arising from the use of my content.
