"The fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. It is not a new normal; it is old normal.” - Dimensional Fund Advisors
This is the era of big tech. Outsized gains and growing market share, tech heavyweights have been the darlings of Wall Street for the past 10 years. Furthermore, technology is woven throughout our daily lives. We can easily draw a line between what these companies do and our personal experience, including owning a particular stock. This can create a powerful bond between investor and company.
iPhone, iPad, and Airpods.
Microsoft Word, Excel, and PowerPoint
Amazon's ease of use and fast delivery for Prime subscribers
Facebook and Instagram to share insights into our lives and check up on friends
Google's search engine
It's easy to see why investors have grown attached to these brands. Many believe the future prospects for these companies is brighter than ever, despite their massive returns and sheer size.
There's growing chatter about how big tech makes up a sizable and growing portion of the U.S. stock market.
The S&P 500 is a market-cap weighted index. Simply put, market-cap = share price x number of shares outstanding. The largest market cap stocks or largest companies represent the biggest share of the S&P 500.
The above graphic shows the top holdings of the S&P 500 (SPY ETF). The big five makes up about 22% of the S&P 500.
Through time, the biggest companies tend to represent a sizable share of the major indexes. The current weighting of big tech is not an outlier by historical standards.
Source: Bespoke Investment Group
While stock indexes tend to be top-heavy, the biggest companies tend to turnover through time...
Source: Charlie Bilello
The above chart shows the top ten biggest companies by decade. The list is from 2018, but the point should be clear; it's not easy to stay on top!
What are the future return prospects for companies that are the biggest in the world?
According to a DFA study, becoming one of the 10 largest stocks has translated into lagging the market over the next five and 10 year periods. The data is summarized below:
Source: Dimensional Fund Advisors, MarketWatch
The above graph shows 1, 5, and 10 year future returns, relative to the overall market, for companies after they become one of the 10 largest stocks. For example, if the S&P 500 returned 5% per year for the next 10 years, the largest companies would hypothetically trail the market by 1.5% per year.
Blame it on the law of large numbers, antitrust, mismanagement, changing economy, competition, change in consumer preference, etc., whatever the reason, it's really hard to grow when a company becomes among the biggest in the world.
Here's a visual walk down memory lane to show how quickly index leadership can change (below graphics courtesy of Visual Capitalist)...
We like big tech and own it across client portfolios. However, investors expecting uninterrupted outsized returns going forward might be disappointed. The law of large numbers is hard to overcome.