The following article appeared in the Money section of the Sunday Times newspaper. 

ABBA are one of the most successful musical acts of all time, selling 150 million records worldwide.Not only that, the lyrics of one of the Swedish supergroup’s hits, “The Winner takes it all” can help you understand how the stock market works.

The winner takes it all / The loser has to fall / It's simple and it's plain / Why should I complain?

Not all stock market companies are created equal. Indeed, a very large number of listed companies provide mediocre returns. Hendrik Bessembinder, a finance professor from Arizona State University, found a minority of companies provide the majority of the returns in the stock market. Bessembinder estimates that $32 trillion of wealth - returns in excess of treasury bills - was created between 1926 and 2016 by about 25,300 stocks traded in the U.S.

Of these stocks, he found that the 90 top performers – less than 0.4 per cent – were collectively responsible for more than half of the total wealth creation. The most astonishing fact is that just over four per cent of the companies account for all the wealth created. The winners in the stock market truly ‘take it all.’ Just five companies accounted for 10% of the total return, so if you didn’t invest in  Exxon Mobil, Apple, Microsoft, General Electric, and IBM you missed out. It demonstrates that if you try to pick stocks, you are highly likely to miss the small number of companies that turn out to be winners.

Picking tomorrow’s winners is not simply a case of looking at the companies that have been successful in the past. The business world is relentless. One of the most memorable business articles is the November 2007 edition of Forbes, which featured Nokia, the mobile phone company. The headline read “One billion customers – can anyone catch the cell phone king?.” If you had a mobile phone in the early 2000s, it was most likely a Nokia handset, so the headline reflected the enormous popularity of the Finnish multinational at that time. However, Apple launched the iPhone that same year and revolutionised the marketplace. It pulled off one the greatest comeback stories in business and became one of the largest companies in the world – today, its market valuation is over $2.3 trillion. By contrast, Nokia’s market valuation fell from about $250 billion to about $29B today.

The music industry is similar to the stock market, in that the fortunes of pop groups ebb and flow. The winners tend to be a handful of acts, like ABBA, who dominate for a decade or so. The business rewards accrue to these small set of supergroups. As a new generation grows up, and musical tastes change, these groups are eventually replaced. Similarly, the stock market, which is essentially a collection of businesses, is always changing.

In his book, Scale, Geoffrey West calculated that “Of the 28,853 companies that traded on the US market since 1950, 22,469 or 78% per cent, had died by 2009”. This mostly occurred through company takeovers, mergers, delisting’s from the stock market, or business failures. In fact, West found, half of all companies in any given cohort of U.S. publicly traded companies disappear within ten years.

So, what are investors to do in an ever-changing world? Investors do better when they apply simple solutions to the complex world of investing. Investing in a globally diversified equity portfolio that tracks the performance of the stock market will increase the likelihood of having a better investment outcome as you have exposure to all the winners. For example, from 1994-2017, the annual return from an all-world equity index was 8%. If you excluded the top 10% of best-performing stocks, your return would have more than halved, falling to 3.6% per annum. If you excluded the top 25% of the best performing stocks, your return would have been minus 4.4% a year. These may sound like abstract numbers, but the impact is real. By failing to capture the returns on offer from the stock market, you may limit your own financial choices in the future.

Stock returns are not uniformly distributed- some stocks do well, some not so well, but by remaining diversified you maximise the chance of capturing the returns available from investing in the stock market. The less diversified a portfolio, the less likely it is to hold the small percentage of stocks that account for most of the market’s long-term return. Stick to a globally diversified equity portfolio and you will always invest in the winners that take it all.