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Is bigger always better?

Updated: Jan 18, 2022

As of today, the 3 biggest stocks in terms of market capitalization are Apple, Microsoft, and Alphabet (Google), in that order. These companies must be something right. So why not focus one's investment on these largest companies? Does buying the largest stocks of the companies that have done really well typically bring above-market returns?

As companies grow to become some of the largest firms trading on the US stock market, the returns that push them there can be impressive. But not long after joining the Top 10 largest by market cap, these stocks, on average, lagged the market. Figure 1 below depicts how companies performed after they joined the top 10, when compared to Fama/French Total US Market Research Index, 1927–2020.

Figure 1. Performance after joining Ten Largest Companies

Note that:

• From 1927 to 2020, the average annualized return for these stocks over the three years prior to joining the Top 10 was nearly 25% higher than the market. In the three years after, the edge was

less than 1%. 2

• Five years after joining the Top 10, these stocks were, on average, underperforming the market—a stark turnaround from their earlier advantage. The gap was even wider 10 years out.

• Intel is an illustrative example. The technology giant posted average annualized excess returns of 29% in the 10 years before the year it ascended to the Top 10 but, in the next decade, underperformed

the broad market by nearly 6% per year. Similarly, the annualized excess return of Google five years before it hit the Top 10 dropped by about half in the five years after it joined the list.

The takeaway: expectations about a firm’s prospects are reflected in its current stock price. Positive news might lead to additional price appreciation, but those unexpected changes are not predictable.

See Dimensional Fund Advisor's one-pager for details and disclaimers linked here.

I'm happy to talk this subject over with you on a complimentary call. As a fee-only fiduciary advisor, I never receive commissions and therefore am unbiased on this topic.

Disclaimer: Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.

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