When you first look at the stock market, it looks like a sea of opportunity.
Thousands of companies. Dozens of sectors. Countless trends to invest in.
But here’s the uncomfortable truth: Most stocks will lose you money.
That’s not an exaggeration. It’s simple math.
Chris Reilly here, filling in for Stephen today...
Did you know a landmark study by Arizona State University found that over the past century, just 4% of stocks have accounted for the entire net gain of the US stock market?
The other 96% were either flat, down, or so volatile they gave back everything they made.
Think about that. For every Nvidia (NVDA) or Apple (AAPL), there are thousands of names that never went anywhere.
Investment bank JPMorgan Chase & Co. (JPM) echoed the same thing. Almost half of all stocks suffer “catastrophic losses,” defined as a drop of 70% or more with no rebound.
The stock market is more of a minefield than a sea of opportunity.
According to Stephen, this isn’t some strange coincidence:
We see this phenomenon outside of investing, too.
In the NBA, just two teams—the Celtics and the Lakers—have won nearly half the championships.
A few writers dominate the bestseller lists, while most others barely sell a few hundred copies.
One search engine—Google—owns nearly 90% of the global search market.
We call this effect the Power Law.
Here’s why this is so important:
- Most investment advisors ignore the Power Law at their clients’ expense.
In a Power Law world, the right single stock can do more for your portfolio than dozens of “safe” bets ever will.
Yet most traditional strategies are built around the idea that diversification and valuation are the only path to success. Pick a few tech names. Sprinkle in some cyclicals. Stay away from stocks trading at 60X earnings.
This approach assumes that all stocks have equal potential. But that’s not the world we live in.
The Magnificent 7—Apple, Nvidia, Amazon (AMZN), Alphabet (GOOG), Meta Platforms (META), Tesla (TSLA), and Microsoft (MSFT)—have been amongst the best stocks on Earth over the past 15 years.
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$1,000 invested into each of these stocks ($7,000 total) at the start of 2010 is worth almost $900,000 today… all thanks to seven “simple” stock picks.
Finding Power Law stocks is hard. Most people should just buy the index and get on with their lives. But if you want bigger, faster returns, then using the Power Law to your advantage is the only way.
Which raises the real question:
- How do you find the handful of companies that drive all the returns?
After years of studying market winners, we’ve found that nearly all of them exhibit three common characteristics before they become dominant.
At RiskHedge, we call these the Three Powers:
The Power of Possibility. The Power of Adoption. And the Power of Misunderstanding.
Let’s break each one down.
The Power of Possibility.
Exceptional companies often emerge at the edge of something new.
A new platform… a new technology… or a shift in infrastructure.
Take Walmart (WMT), for example. It built a whole new retail model that depended on one key development: mass car ownership.
Before cars, people needed shops in the town center that they could access on foot. Because real estate was scarce and expensive in town, those shops tended to be small.
Mass car ownership opened up a whole new world of possibilities. It allowed Walmart to build massive stores on cheap land outside of town. And it turned Walmart into one of the all-time great stocks. A $1,000 investment into WMT in 1972 is worth around $5.7 million today.
Tesla’s rise followed a similar pattern.
Electric vehicles (EVs) had been around for over a century. But only after breakthroughs in lithium-battery tech did EVs become viable. Tesla seized that moment and scaled faster than anyone imagined. Its stock surged as a result, turning Elon Musk into one of the richest men on the planet.
Or look at Apple. The first iPhone was a marvel of design. A sleek touchscreen device with the internet in your pocket. But it ran on slow 2G and 3G networks. It was 4G’s arrival in 2010 that opened a world of possibilities for iPhone’s users.
Sharing photos and videos on social media, real-time navigation, watching YouTube, videocalls, and so on became seamless. The iPhone turned into a remote control for modern life. Apple ballooned into the largest company in the world as a result, making many investors rich in the process.
The lesson: A stock profiting from a new possibility is a potential big winner.
The Power of Adoption
A new technology in itself is not enough. It must change behavior.
Faster Wi-Fi speeds opened up the possibility for Netflix (NFLX) to stream HD movies. But its long-term success came when people changed how they consumed entertainment.
They developed a new habit. No more driving to a store to rent DVDs. No more late fees. Just one-click access to anything, anytime. Friday night at Blockbuster turned into bingeing House of Cards on the couch.
Uber (UBER) didn’t just make taxi services more efficient. It rewired how people thought about transportation. The idea of getting into a stranger’s car went from unthinkable to normal in just a few years. As did ordering a cab with a few taps on a screen instead of waving at one from a curb.
Spotify (SPOT) did the same for music. The idea of streaming tracks from the cloud was technically possible before Spotify, but few people did it.
Spotify changed the experience. Instant access to nearly every song in the world, available anywhere, without the need to own a single file. That shift rendered piracy and MP3 downloads into relics.
It also completely changed how we consume music. Playlists replaced albums. Algorithms replaced radio. And Spotify became the default way millions listen to music daily.
Great companies make people adopt new habits. It’s why their stocks can surge for years.
The Power of Misunderstanding
The market isn’t always rational. In fact, it often gets things wildly wrong, especially early on.
Stephen again:
When a new idea is widely understood and fully appreciated, its price usually reflects that. But when an innovation is misunderstood, dismissed, mocked, or ignored, it creates a gap between price and reality.
That gap is where outsized returns live.
In its early days, Amazon was misunderstood as an unprofitable online bookstore.
Bitcoin (BTC) was dismissed as a scam and a bubble.
Nvidia was seen as just a gaming chip company.
All three made countless investors rich.
Even the internet itself was once described by a Nobel economist as a fad with no more impact than the fax machine.
These misperceptions don’t just exist among everyday folks. They’re usually held by industry veterans and institutional thinkers.
And that’s what creates the opportunity.
- The next time you buy a stock, ask yourself this question:
Does this company sit at the intersection of possibility, adoption, and misunderstanding?
If the answer is yes, then the Power Law will work to your advantage.
In their Disruption Investor advisory, Stephen and his co-editor Chris Wood use the Power Law principle to hunt for great businesses profiting from disruptive megatrends.
In their latest issue of Disruption Investor, for example, Chris and Stephen recommended three companies playing critical roles in the artificial intelligence (AI) megatrend.
From specialized chips that move data quickly between data centers… to switching systems that act as “digital highways” for data… to liquid-cooling tech that keeps electrical components from overheating… these companies provide necessary infrastructure for the next phase of the AI boom.
Disruption Investor members can get caught up on their latest picks here.
If you’re not a member and are interested in learning more about these companies, sign up for Disruption Investor today to get immediate access to the September issue and the full Disruptor 20 portfolio.
Chris Reilly
Executive Editor, RiskHedge