July 14, 2020

The world is changing, this crisis has cemented the dominance of a handful of very large technology companies (FAANG – Facebook, Amazon, Apple, Netflix, Google). Why shouldn’t investors just focus on them?

Investors may be surprised to learn that it is not unusual for the market to be concentrated in a handful of stocks, but keep in mind that any expectations about the future operational performance of a firm are already reflected in its current price.

Tech standouts are drawing attention for their perceived sway on stocks, but history undercuts that view.

A breakdown of the largest US stocks by decade in Exhibit 2 shows some companies have stayed on top for a long time. AT&T was among the largest two for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 at the start of multiple decades. IBM and Exxon were also mainstays in the second half of the 20th century. Hence, concentration of the stock market in a few large companies such as the FAANG stocks in recent years is not a new normal; it is old normal.

Moreover, while the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology. AT&T offered the first mobile telephone service in 1946. General Motors pioneered such innovations as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, halogen bulb, and the LED. So technological innovation dominating the stock market is not a new normal; it is an old normal too.

Another trend attributed to a new normal is the extraordinary performance of FAANG stocks over the past decade, leading some to wonder if we should expect these stocks to continue such strong performance going forward. Investors should remember that any expectations about the future operational performance of a firm are already reflected in its current price. While positive developments for the company that exceed current expectations may lead to further appreciation of its stock price, those unexpected changes are not predictable.

To this point, charting the performance of stocks following the year they joined the list of the 10 largest firms shows decidedly less stratospheric results. On average, these stocks outperformed the market by an annualized 0.7% in the subsequent three-year period. Over five- and 10-year periods, these stocks underperformed the market on average.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Original article can be found at https://us.dimensional.com/perspectives/large-and-in-charge-giant-firms-atop-the-market-is-nothing-new