With large firms dominating, are there only a few companies worth investing in?
FT explored an interesting topic: Does the winner take all in investing and are there only a few companies worth investing in?
Backing it up: In the past 40 years, only 10% of all stocks became “mega winners” with 500%+ total returns.
Within an industry, investors can associate a dominant firm — Apple dominates consumer electronics, Facebook with social media, Tesla with electric vehicles, Netflix with streaming and the list goes on…
By investing in dominant firms, investors would have easily beaten the market. But the trick is figuring out which ones they are.
According to Brian Arthur, several traits are common among dominant companies:
- High cost (often unprofitable) in early stages of product development (i.e. Netflix lost money building out their content library).
- Network effect — the more users on the platform, the better the platform (i.e. More homes on Airbnb leads to more options for renters).
- Dependence on industry standards (i.e. Google Search, Microsoft Windows).
As these companies grow, they gain size advantages (i.e. lower cost, greater distribution) — giving them an even greater edge.
Investors: Is investing in super firms a sound strategy? According to Robert Armstrong (via FT), it’s difficult to see which firms are dominant and will stay that way — IBM and General Electric were two dominating firms that are now struggling.
His recommendation: Stick with index funds.
Expiry date: Past data also shows that sticking around in dominant firms isn’t such a great idea over the past 10 years.
- Even if the company continues to dominate competitors, their stock returns might not.
- Top-performing stocks in one decade have less than a 20% chance of staying at the top in the next decade.