Too Big To Succeed?
In a short white paper and an earlier FAJ Editor’s Corner, one of us (Arnott, 2005 and 2010) examined the performance of top companies (by market cap) in the U.S. market. The study shows that, on average, the sector leader underperforms the average stock (equally weighted4) in its own sector over the subsequent 1-, 3-, 5- and 10-year time horizons.
An updated version of that research is shown in Figure 1. The results are impressive.
Do the added obstacles faced by winners hurt their investors? Yes. In fact, we find the leader in any sector underperforms the rest of its sector (equally weighted) by 4 percent in the next year ... and the next year … and the next year. As Figure 1 shows, the damage doesn’t really slow down for at least a decade, as the sector top dog lags its own sector by 3.7 percent per year for the next decade! Put another way, with compounding, the top stock in each of the 12 U.S. market sectors declined over 30 percent in value in 10 years, relative to the competition in its respective sector, over the past 60 years. Adjusting for overlapping samples, we find t-statistics ranging from 4.7 to 6.2, all highly significant.
These shortfalls are large and statistically significant. But were these results dominated by a few large outliers? For example, how consistently did these sector top dogs fall short relative to the average stock in their own sectors? On a one-year basis, only 42 percent of the sector top dogs were able to beat the average for their respective sector competitors. This anemic win rate keeps tumbling with time. On a 10-year basis, fewer than three of 10 were winners. For the one-year result, we have 719 samples (60 years of data for 11 sectors, and 59 years for utilities), for which the top dog won in only 303 cases and lost in 416 cases. That’s a pretty lopsided coin toss. On a 10-year basis, we have 611 samples; the sector top dog won in 174 cases, and lost in 437 cases.5
Our research also shows that sector top dog status changes frequently. In most sectors, the top dog is replaced several times over the 60-year time span. The average sector has seen six top dogs over that span, while the "other" sector (stocks that don’t neatly fall into one of the other 11 sectors) has had a remarkable 13 different top dogs. With 13 different top dogs claiming and losing the No. 1 spot in the "other" sector, it’s no wonder that the 1-, 3-, 5- and 10-year shortfall for these top dogs is nearly always worst on the list.