Should You Invest in the Largest Stocks?
By Schultz Collins Investment Counsel on August 18, 2023
In this month’s commentary, we examine the historical returns associated with the largest stocks in the market.
As we have discussed previously, investors have a natural attraction towards the best performing individual stocks. As some stocks rapidly grow, a few become the largest companies when measured by market capitalization. Some investors take comfort in buying the largest companies believing their size represents a degree of security to their principal, and that past performance provides some assurance of future positive returns.
When we talk about a company’s size, we are usually talking about its market capitalization. What is market capitalization? It is a simple calculation of the price per share multiplied by the number of shares outstanding. As the stock price increases, so does the company’s market capitalization.
Company Size Measured By Market Capitalization
Stock Price x Shares Outstanding = Market Capitalization
For illustrative purposes only. Data provided by Dimensional Fund Advisors as of 7/28/2023
So, what does history tell us about the success of investing in the top 10 largest companies? Prior to becoming the very biggest companies, the returns on the stocks of these companies can be quite impressive. However, not long after joining the top 10 largest companies, these stocks, on average, have underperformed the market.
According to Dimensional Fund Advisors, from 1927 to 2022, the average annualized return for these stocks over the three years prior to joining the top 10 was almost 27% higher than the market. Three years after joining the top 10, these stocks, on average, underperformed the market. As time passed, the return gap widened to 1% per year after five years and 1.7% per year ten years out.
It is tempting to look at previously very successful stocks and believe those same relative returns will continue into perpetuity. On average, history says otherwise.
Kenneth Clift
Director of Advisory Services and Co-Chair of the Schultz Collins Investment Committee.
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Schultz Collins Investment Counsel is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC (member FINRA and SIPC). Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.
This is not an offer to buy or sell securities, nor should anything contained herein be construed as a recommendation or advice of any kind. Consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. No investment process is free of risk, and there is no guarantee that any investment process or investment opportunities will be profitable or suitable for all investors. Past performance is neither indicative nor a guarantee of future results. You cannot invest directly in an index.
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