During the global financial crisis, many banks were bailed out because they were ‘too big to fail’.
Now research has found that some companies listed on a share market are not good investments because they are ‘too big to succeed’.
A report by US firm Research Affiliates has found that many large companies in the US can underperform their peers for up to 10 years once they reach the number one position in their sector.
One thing that happens is that large, dominant companies tend to attract the attention governments and regulators.
“Was Goldman Sachs targeted with civil and criminal fraud charges because they have criminal intent to defraud their clients, while their competition is pure as the driven snow? Or have they become a symbol of success-to-excess, and pundits to want them to suffer?
“Is Exxon Mobil regularly pilloried in Washington because people think that their business practices are monopolistic, their profit margins obscene, and their product is polluting and distasteful (never mind that we all buy it)? Or is it because their relentless business success makes them a popular target?
“Microsoft’s opportunity in the spotlight came a decade ago, when they were attacked on the grounds of ‘monopolistic’ business practices, as was IBM in the prior decade.
The decade before that, AT&T was successfully dismantled on the same basis.
Its research has found the leader in any sector underperforms the average stock in its own sector by 3.5% per year for a multi-year period.
“The damage doesn’t really slow down for at least a decade, as the top dog in each sector lags its own sector by 3.3% per year for the next decade! With compounding, the top stock in the 12 market sectors declined 28% in value relative to the average stock in its respective sector.”
There is one mitigating factor; in most sectors, the number one position changes frequently. Therefore, it can be worthwhile owning a large, dominant company but it may be better to own number two or three that is on the way up, rather than number one which is sticking its head above the parapet for competitors, regulators and the government to take potshots at.
A quick look at the New Zealand and Australian markets shows the “too big to succeed” label appears to apply here.
There are any number of large companies that are regulated by the government or regulatory authorities in the areas of telecommunications, gambling and energy, for example. Many of these companies have underperformed the market in recent years.
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