Making market returns is easy. Beating the market is very hard

The title of this post was taken from the following tweet by Rohit Chauhan

5 year returns for the market is around 8% CAGR. No. of companies which had a CAGR > 8% was around 400 or 5% of the market. The ex-ante probability of an investor to beat the market is < 5%.
Making market returns is easy(Index funds). Beating the market is very hard

— Rohit Chauhan (@rohitchauhan) November 13, 2019

When I first read the tweet, I was stumped. If just 5% of the stocks were able to generate better returns than the Index, there is really no point being in the business of selecting stocks. For a while its been said that beating the markets is difficult, but if it’s just 5%, it’s close to impossible.

I decided to test the same for myself. To also ensure that starting point bias doesn’t screw up the numbers, I decided to test for 3, 4, 5, 6 and 7 year returns. The idea was to verify the percentage of stocks that generated a return greater than the Index.

For this exercise, I used data from NSE. As on date, NSE has 1900 companies that are available for trading. But this is not a static number. If you go back 10 years (2009), this number was around the 1400 mark.

600 are the Net additions post removal of stocks due to delisting and hence the number of stocks that you can find 10 year returns will not be 1900 or even 1300 but much lower. To give you an example, if you were to check for 10 year returns of all stocks, the number of stocks come to 2300. Of these, 600+ stocks have ceased to be available for trading. Then you have another 250+ stocks that don’t have 10 year returns since they were listed in the interim period.

This leaves us with (2300 – (636+252)) = 1412 stocks that have 10 year rolling returns. We need to account for the fact that nearly 27% of stocks that were available  for investing 10 years ago aren’t available today. 

I account this to ensure that the data doesn’t fall prey to Survivor Bias. Do note that tocks that went through demergers and hence had new symbols and prices get removed since they may not have the required amount of data.

Here are the results;

The good news, the number of stocks that have given returns greater than Nifty is not 5% or even in single digits. 3 Year look-back has the lowest number of stocks that have generated returns greater than Nifty and one which isn’t surprising given that over the last two years, it’s been a rally led by a few large caps with small and mid caps nowhere in the picture.

The best returns came for the 6 year period, again not surprising since 6 years back, it was 2013, Modi had been annointed the Prime Minister candidate of the BJP and markets had just started the rally that finally ended in Jan of 2018.

It’s generally in the last phases of a mega bull run that picking stocks become easy. Rest of the time, it requires hard work to be able to spot long term winners. Yet, the fact that hundreds of stocks have been able to beat the Index returns should provide investors the faith that is required to be an active investor. The day, this ratio falls to 5% is the day one should quit active and move to passive.