Too big to succeed: are leading corporates set for a fall?

Companies recognised as sector or market leaders represent poor prospects for investors over the next decade, says recent research.

The study, entitled The Winner’s Curse: Too Big To Succeed?, reports that companies that rise to become number one by market capitalisation in their sector are typically punished – often severely – in subsequent market action.

Authors Robert Arnott or Research Affiliates and Lillian Wu of the UCLA Anderson School of Business found that 59% of ‘top dog’ US companies underperformed their own sector in the following year, with two-thirds lagging their sector over the subsequent decade.

A “daunting magnitude” of average underperformance by such companies sees their share prices trail their sectors by between 300bps and 400bps per year over the following decade, the authors said.

“We find the same phenomenon in each and every market, with no exceptions. Indeed, outside the United States, the sector top dogs generally underperform their own sector even more relentlessly than in the United States.”

“When you are number one, you have a bright bull’s eye painted on your back. Governments and pundits are gunning for you. Competitors and resentful customers are gunning for you.”

Arnoot and Wu said investor attitudes to such companies are frequently skewed by the assumption past successes will continue in future and mean reversion will not take place.

“The market becomes aware of such pricing errors only gradually, as the company fails to meet the unrealistic growth expectations imposed upon it. In short, size itself is becoming less of an advantage and more of a curse.”

Leading companies even outperformed when measured against equally-weighted peer performance: over the following five years, country, sector and global ‘top dogs’ lose between 17% and 36% of an investor’s wealth relative to “a relevant equally weighted peer comparison”.

One exception to the rule, the study suggests, may be the energy sector, where ExxonMobil has been able to outperform the sector by 0.8% per annum in the ten years since it became ‘top dog’.

The study suggests a number of reasons for this resilience, including the company sticking to core competencies and the 1999 merger between Exxon and Mobil which combined the top two companies in the sector.

Elsewhere, however, the findings are conclusive.

“The organisation with the number one rank in market cap will often be a truly great company, but empirically is not necessarily a good investment. Therefore, investors should anticipate the underperformance of large companies relative to the overall market,” the authors said.

 

This article was first published on Investment Week

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