Many business executives, management consultants, financial analysts, and investors have ransacked lists of thriving companies, looking for shared characteristics that explain their success. The results are generally disappointing in that the traits that are discovered are more likely to be coincidences than secrets for success.
The fallacy of selecting traits after identifying successful companies [1]is known by a variety of names, including the “Feynman Trap” and the “Texas Sharpshooter Fallacy.” This latter fallacy supposes that a self-proclaimed (Texan) marksman shoots a bullet at a blank wall and then draws a bullseye around the bullet hole. This proves nothing at all, because there will always be a hole to draw a circle around. In the same way, any group of companies (great, good, or bad) will inevitably have several common characteristics. Since we are bound to find shared traits, finding some proves nothing. A persuasive test of any set of proposed secrets for success must specify the traits beforehand. The target must be drawn before firing the gun.
Are there any objective criteria, selected beforehand, for predicting which companies will be successful and which stocks will be profitable investments? Indeed, there are.
Since 1983, Fortune magazine has been publishing an annual list of “America’s Most Admired Companies.” The Fortune list is based on a survey of thousands of business executives, directors, and analysts who rate the largest companies in their industry on eight key attributes that Fortune’s editors believe are crucial for success: innovation; people management; use of assets; social responsibility; management quality; financial soundness; long-term investment, and product quality. In recent years, a ninth attribute (global competitiveness) has been added to the list.
The Fortune list is based on a set of ex ante criteria identified before comprising the companies. The same measures of successful companies are used year after year. Instead of looking for ex post traits that are common to admired companies, it looks for companies with admirable traits that have been specified beforehand.
The performance of Fortune’s 10 most-admired stocks can be analyzed by constructing an Admired portfolio. The Admired strategy begins by investing $1,000 in each of the 10 most-admired stocks on the 1983 issue’s official printed publication date.
Each year thereafter, the portfolio is liquidated on that year’s publication date and the proceeds are invested equally in that year’s 10 most-admired companies. (Investors can easily implement this strategy because the magazine appears roughly a week before the stated publication date.) For comparison, an Index strategy was created by investing $10,000 in the S&P 500 SPX, +0.20%[2] , starting at the same time as the Admired strategy.
The chart below compares the value of the Admired portfolio to the value of the Index portfolio since 1983. The annual return on the Admired...