Why the “Big Five” Are Not Forever

My youngest daughter will be a good investor.

That is because she’s a deep thinker. She proudly likes to say, “Daddy says I ask the best questions” – and she does.

The kid shocks me with what comes out of her mouth sometimes.

I remember one occasion when she couldn’t have been more than 3 years old. We were in the car coming back from swimming lessons at the YMCA. We were stopped at a red light, and she was staring out the window, deep in thought.

Curious as to what was going on in that little head, I asked her what she was thinking about.

She turned to me and said, “Oh, I was just wondering who the first person on Earth was…”

A bit stunned, I asked her what she thought.

Without missing a beat, she immediately responded with what she had already decided was the best answer.

“Santa Claus.”

I told her that was as good a guess as any. In fact, it was better than most.

Always looking to feed my daughter’s inquisitive nature, last week I showed her a statistic that blew her mind: There are 1 billion trillion stars in our observable universe.

That is what is observable – and we can observe only parts of the universe within 13.7 billion light-years of Earth. Who knows how many more stars are actually out there!

In finance, it also pays to be inquisitive. And while market watchers may be more concerned with which company will be the last standing than with which walked the Earth first, it’s important to ask the tough questions…

For instance, in our “observable universe” of the S&P 500, why are the current market valuations of the five largest companies on par with the number of stars out last night?

Tech Companies Outshine the World
The five largest companies in the S&P 500 are referred to as the “Big Five.” Today, the companies in the Big Five sport these market capitalizations:

  • Apple (Nasdaq: APPL): $1.53 trillion
  • Microsoft (Nasdaq: MSFT): $1.47 trillion
  • Amazon (Nasdaq: AMZN): $1.3 trillion
  • Alphabet (Nasdaq: GOOGL): $986 billion
  • Facebook (Nasdaq: FB): $671 billion.

Those are numbers that we used to associate with entire countries – not single companies.

As a group, these five now represent nearly one-quarter of the entire S&P 500.


The last time the percentage of the S&P 500 was this concentrated in the five largest stocks was in 1978.

Should You Invest in Them?
The five companies that dominated the S&P 500 in 1978 were General Electric (NYSE: GE), General Motors (NYSE: GM), Exxon Mobil (NYSE: XOM), AT&T (NYSE: T) and IBM (NYSE: IBM).

If history is any guide, today’s Big Five might not be great stocks to own going forward…

After rising to represent one-quarter of the S&P 500, the 1978 Big Five went on to underperform the index by a wide margin.

General Motors went bankrupt during the 2008 to 2009 financial crisis, sending its stock to zero.

A $10,000 investment in 1978 in each of the other four stocks and an S&P 500 index fund would have resulted in the following…


The best performer of the four was Exxon, which turned $10,000 into $91,950. That pales in comparison to the $206,110 that the S&P 500 index fund created.

The performance of the others has been abysmal…

The average result of a $10,000 investment in those five stocks in 1978 through today is only $47,064 – just a fraction of what the overall market has produced.

It represents a terrible performance over four decades.

Is This 1978 All Over Again?
Will Apple, Microsoft, Amazon, Alphabet and Facebook follow a similar underperforming fate to the Big Five of 1978?

As with some of my daughter’s deep questions, that’s difficult to answer…

The Big Five of 2020 are truly great businesses. As a group, these companies have the best business models ever. They require very little capital and have strong recurring revenue streams.

But their size is working against them. When your starting point is a valuation that is more than $1 trillion, it’s hard to grow.

That is important because over time, it is growth that drives stock market returns.

If I absolutely had to bet on whether or not the Big Five of 2020 would outperform or underperform the market going forward, I would insist on knowing the time period I was expected to answer the question for.

Over the next five years, these companies could still outperform. But the further we look out in the future, the less I like their chances.

I certainly wouldn’t bet on this group outperforming over the next four decades.

Why?

The average age of these companies is just 29 years old. That is the average – a couple of these companies aren’t even of legal drinking age yet.

In 1978, we couldn’t have predicted that this group of companies would become the Big Five of the S&P 500 because none of them even existed.

All of these companies are likely to face future challenges that none of us can even imagine today…

Which is what makes investing so challenging and so much fun.

Good investing,

Jody

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Source: Wealthy Retirement