Should I load up on big companies? Should I sell big companies?

0
34
Should I load up on big companies? Should I sell big companies?


Q: I read recently that very large tech companies like Amazon
AMZN,
+1.78%

 have such dominant positions, it is probably best to own tons of their stock. Do you agree?

Thanks,

Tim

Q.: Dan, I read an article that said the market value of a few tech companies (Facebook
FB,
+2.29%
,
Apple
AAPL,
+3.15%
,
Google
GOOG,
+1.96%

 etc.) are so disproportionately large that 2020 looks a lot like 2000. That bubble burst. This one has to too, right?

Cal in Columbia

A.: Tim, meet Cal. Cal meet Tim. You are both citing the same information but worrying about opposite outcomes. That happens a lot. It is more than a glass half full or empty thing too. It is how markets work. Opposing viewpoints about a stock’s future is normal. You can’t buy a stock unless someone sells it.

It is also normal to see pieces in the financial media citing the same data but presenting cases for an opposite result. These forecasts can sound very compelling. Both contentions you refer to sound logical.

So, which is right? Until a working crystal ball comes to market, no one can know for sure but we are all free to make predictions. Nonetheless, a few things that are known should also be considered.

Absolutely, the prices of these stocks could drop precipitously but it is hard to say that the concentration in a few companies in and of itself will drag down broader markets. Broadly diversified portfolios held up fine during the tech wreck of 2000, for instance, because there were several asset classes that did well.

The top-heavy condition we see today is not new or odd. According to a recent study by Dimensional Funds, from 1927 to the end of last year, the market value of the top 10 stocks in the S&P
SPX,
+1.52%

 averaged about 25% of the market value of all companies in that index. Today, the top 10 account for roughly that same percentage. The index was more top-heavy than this average for the first 40 years of its existence than it is now.

It may also be good to keep in mind that these mega companies have such high market values because the prices of their stock have risen tremendously in recent years. Historically, the list of the 10 largest companies has changed with technological innovation. Often, a few successful disruptors experienced significant increases in the price of their stock ousting incumbents out of that top 10. What tends to happen is companies with such strong runs in performance and stock returns get so big, they have a hard time continuing their run, opening the door for a slew of new disruptors trying to repeat the feat.

You can see this slowdown in the data. Following the year in which these companies joined the list of the 10 largest firms, on average, these stocks barely outperformed the market in the subsequent three-year period. After five years from entering the top 10, these stocks underperformed the market on average and by the 10th anniversary they lagged behind the market they had beaten so soundly on their run to the top by an annualized 1.5%.

I would be shocked if Amazon, for instance, didn’t continue to make a ton of money, but loading up on Amazon stock does not necessarily translate to better returns going forward. What matters for your return is whether the price goes up from the price at which you bought. That’s it.

The fewer stocks you own, the riskier your approach. Sometimes that pays handsomely. Most of the time it has not. Very few stocks produce market beating returns for very long. A popular alternative to betting on the future of a few stocks is to be broadly diversified. By being less dependent on a few holdings, the future of their stock prices is less important. You are not likely to have top tier results, but you also dramatically reduce the chances of a disaster if one of your favorites tanks.

If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.

Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo in Orlando, Melbourne, and Tampa, Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.



Source link

LEAVE A REPLY

Please enter your comment!
Please enter your name here