Survivor Bias and Stock Market Risk
Issue:
Shortly after the large stock price decline of Facebook on July 26,2018, CNBC posted an article with a chart of other large market-cap declines of U.S. stocks. Every single company in the chart still exists as an ongoing company. It appears as the chart was compiled from a database that only contain companies that are still listed.
What no longer actively traded companies might have made a list of the largest declines in equity value for large-cap companies?
Why does the exclusion of these companies from the chart create a misleading picture of the risk of investing in equity?
The chart lists three companies with large cap declines in 2018? Why is the occurrence of so many recent large declines in big-cap equity a concern?
The article:
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The Chart: Market Cap Losses in Big Cap Stock |
||
|
Company |
Date | Decrease In Equity ($B) |
|
|
Jul 26 2018 | $114.50 |
|
Intel |
sep 22 2000 |
-90.7 |
|
Microsoft |
Apr 3 2000 |
-80 |
| Apple | Jan 24 2016 |
-59.6 |
|
Exxon Mobile |
Oct 15 2008 |
-52.6 |
|
General Electric |
Apr 11 2008 |
-46.9 |
|
Alphabet |
Feb 2 2018 |
-41 |
|
Bank of America |
Oct 7 2008 |
-38.4 |
|
Amazon |
Apr 2,2018 |
-36.5 |
|
Wells Fargo |
Feb 5 2018 |
-28.9 |
|
Citigroup |
Jul 23 2002 |
-25.9 |
| JP Morgan Chase | Sep 29 2008 |
-24.9 |
Discussion
What no longer actively traded companies might have made a list of the largest declines in equity value for large-cap companies?
Companies no longer actively traded, which experienced large one-day drops in equity value include — Enron, Worldcom, the old General Motors, Lehman Brothers, Bear Stearns, and Merill Lynch. There are probably many more.
Why does the exclusion of these companies from the chart create a misleading picture of the risk of investing in equity?
First, this list suggests large drops in equity values occur less frequently than a chart composed from all firms that ever existed.
Second, a list of large declines composed of stocks that survived understates the potential loss of wealth from buying and holding stocks after a large decline. In fact, all the stocks on the CNBC list have recovered nicely.
Third, an anaysis of risk, which includes bankrupt firms would encourage investors to seek greater diversification in terms of number of equity holdings, sector, and asset classes.
The chart lists three companies with large cap declines in 2018? Why is the occurrence of so many recent large declines in big-cap equity a concern?
Facebook, Alphabet, and Amazon all had their large declines in 2018. These are three of the four FANG stocks. The smallest FANG company also has had a recent large percentage decline.
The most popular trendy sector of the stock market is now realizing extremely large one-day changes. This appears to be happening with greater frequency.
The disproportionate number of 2018 large-cap declines in this chart convinces me that people who have made a lot of money in FANG and in other high-tech stocks need to take some money off the table when the stock prices reach new highs.
Of course, in the case of Facebook this advise was more valuable prior to July 26.
The volatility of FANG names and other Tech stocks does not mean this is a good time to buy value stocks because the pending increase in interest rates might hurt value stocks more than growth stocks
I would be alarmed by the large number of 2018 events even if the chart contained firms that were no longer actively traded.