Awareness of cross-sectional return variation is useful in dealing with matters such as the value of diversification, the potential rewards from individual issue selection and the risk of being wrong in favorable market environments.
An analysis of the variations in annual returns of NYSE-listed stocks over the years 1926-1989, emphasizing the interquartile range in these returns, appears to convey four messages. The most consequential is that cross-sectional variations in common stock returns over a year are large. The implication is that it matters greatly which issues an investor holds. For investors who choose not to emphasize issue selection in their investment policy, diversification is critical. For those who do attempt to pick stocks, the rewards can be very high, but the risks and negative consequences of poor selections are substantial.
The data also show that cross-sectional return variation is reasonably stable from year to year, but it tends to increase in strong stock markets. It has also trended upward in the postwar years, possibly because of higher relative trading volume and greater heterogeneity of NYSE common stocks.