Page 14 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY

Q&A: US Company Consolidation

Andrew Adams, CFA, CMT, Senior Research Associate, Equity Research

Q. IS THE US STOCK MARKET EXPERIENCING A CONSOLIDATION OF the impact of the ten largest stocks in the S&P 500 has not really
POWER AMONG A FEW OF THE LARGEST COMPANIES AND, IF SO, changed much over the last 40 years, even if the specific names on
WHY? that list have changed. The ten biggest stocks currently make up a
shade over 20% of the index’s market capitalization, which is right
A. The US stock market is shrinking in terms of the number of publicly around the average since 1980 when the more cyclical energy
traded companies, a fact that is both a result of, and contributing sector helped the ten largest companies represent a dominating
factor to, the increasing importance of a select few, large 25% of the S&P 500. Today’s large tech companies also happen to
companies. Since 1996, the total number of listed stocks in the be some of the most profitable, with Apple, Google, Facebook and
U.S. has been cut in half – from 7,322 to about 3,600 – as annual Microsoft alone accounting for about 10% of the S&P 500’s total
mergers and acquisitions have doubled and the average number profits. As such, technology’s place at the top of the market is not
of initial public offerings per year has dropped considerably. unwarranted. Moreover, roughly 23% of the S&P 500 that
Meanwhile, the share of gross domestic product (GDP) generated technology represents today is nothing compared to the 34% it
by America’s 100 biggest companies rose from about 33% in 1994 comprised back in March 2000 at the peak of the dot-com bubble.
to 46% in 2013, meaning not only are there fewer firms in total Considering American corporate profits (as a percentage of GDP)
these days, but a small number of them are taking a greater piece are higher than they have been any time since 1929, elevated
of the pie.
valuations in the stock market are warranted and investors don’t
The concentration at the top is, of course, primarily weighted appear overly concerned.
toward the big technology companies, all of which have seen Consumers have also benefited in a big way, with technological
their products and services become increasingly integrated into innovation throughout history helping to bring down costs and
the lives of their loyal customers. Through innovation, acquisition prices, while making lives more convenient and requiring less
and the power of so-called ‘network effects,’ these modern-day manual labour. As per The Economist, tech companies provide
conglomerates have built dominant, industry-controlling brands Americans and Europeans with an estimated $280 billion-worth of
that continue to gain value as their huge user bases expand. The “free” services per year, such as search results or directions. Even
digital age has witnessed data evolve into the most important the stuff customers purchase provides tremendous bang for each
commodity in the world, and much of the success of these large respective buck. In their book Abundance, authors Peter Diamandis
tech companies is due to the ever-widening ‘data moat’ that and Steven Kotler estimate that modern smartphones contain
exists between them and up-and-comers lacking that established roughly $900,000 worth of applications based on each piece of
network of billions of existing customers.
technology’s original manufacturer’s suggested retail price in 2011
Q. SHOULD INVESTORS AND CONSUMERS BE WORRIED ABOUT THE dollars (video conferencing, GPS, video camera, etc.), which
GROWING IMPORTANCE OF MEGA-CAP COMPANIES? illustrates the value being created by tech’s game-changing
companies. It’s no wonder these disrupting forces are raking in the
A. Despite the growing importance of these technology companies, profits and the cash.

The companies engaged in the technology industry are subject to fierce competition and their products and services may be subject to rapid
obsolescence. Dividends are not guaranteed and will fluctuate. Past performance may not be indicative of future results. Investing involves
risk including the possible loss of capital.

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