For people looking on anxiously as stock wealth converges in an oligarchy of high-tech juggernauts, some perspective: It’s nothing new.
That’s the upshot of six years of research by Hendrik Bessembinder, whose work shows how unevenly the stock market’s rewards are apportioned over time. The Arizona State University finance professor is back with a new study, Shareholder Wealth Enhancement, 1926 to 2022, saying that not only do bizarrely few stocks make up the lion’s share of returns in the last century, but that the pool of superstar companies may be shrinking.
Bessembinder’s paper is of interest to anyone who has worried about how the craze for artificial intelligence mostly confined gains in the S&P 500 to half a dozen companies that account for virtually all of this year’s advance. Treating that basic pattern as unusual is a mistake, his work suggests. In fact, there’s reason to believe the situation is permanent and likely to intensify.
“I can’t tell you which firms are going to be the big winners over the next 30 years, but I feel really confident saying a few firms will dominate the market,” he said in an interview. “It seems to be becoming an even stronger phenomenon that the wealth enhancement is concentrated in a relatively few stocks.”
Bessembinder made waves six years ago with research showing that because companies like Apple Inc. and Exxon Mobil Corp. trounced their peers by so much in terms of returns, less than 4% of stocks trading since the 1920s have generated a majority of the market’s upside. His new study raises the possibility the situation is becoming more entrenched: While five stocks were responsible for 10% of the wealth expansion through 2016, the number shrank to four in 2019 and is just three today.
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Even casual market observers are aware of warnings that the 2023 stock rally rests precariously on just a few giant companies. In truth, rarely has a rally occurred in the last decade in which the same alarm wasn’t raised. Similar caution was counseled throughout the Faang-fomented bull run of the late 2010s. Heeding it would’ve kept investors out of one of the market’s strongest-ever five-year runs.
Why does the concentration occur? At the simplest level it reflects the role of profits — bigger companies earn more. An analysis by Bloomberg columnist Nir Kaissar showed that more money a company makes, the higher its market value tends to be. Trailing 12-month net income of S&P 500 companies is strongly linked to their market value, with a correlation reading of 0.82 over time. (A correlation of 1 implies that two variables move perfectly in the same direction.)
Another factor is the effect of compounding. While Bessembinder’s study uses a comparison with Treasury bonds, an approach that controls for inflation, the ability of some companies to build gains upon gains means some concentration is inevitable when it comes to stock market returns. That is, chance alone ensures that a few firms will mushroom in size over time.
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Still, the degree of concentration raises the possibility different forces are contributing to the lopsidedness.
Clearly the market has a propensity to reward innovations and things in high demand — manufacturing in the 1920s, energy in the 1970s, internet technology in the 1990s. It’s possible rising barriers to entry and the benefits of scalability — what is sometimes referred to as the “winner-take-all” economy — are narrowing the list of champions. In today’s knowledge-based world, software- and internet-driven megacaps command quasi-monopoly market power and possess head starts in terms of development.
“The markets are telling us that they think that a relatively few firms are likely to be able to capture a bigger slice of the cash flows,” said Bessembinder. “Is it firms that are positioned to cash in on AI? It seems plausible, but I can’t go further than that.”
Tracking 28,114 individual stocks over almost a century, Bessembinder calculated the changes in their value over time and took into account the impact from corporate actions that add or subtract a stock’s value for shareholders, such as dividends, share buybacks and additional offerings. Then he used returns from Treasury bills to derive a number on how much wealth a company has created or destroyed for shareholders during its lifetime relative to a risk-free investment.
By his tally, US stocks added $55 trillion in aggregate worth for investors in more than nine decades. Over the stretch, Apple, Microsoft and Exxon Mobil are the largest money-making machines, accounting for almost 11% of the total increase.
While four of the top five are tech firms, the lineup gets more diversified when one goes down the ladder of rankings. The next 10 largest wealth creators span industries from retailing to health-care and financials.
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The study is one of a series published by the researcher in recent years about the stock market’s top-heavy nature, papers that ignited a heated debate about the relative merits of active and passive investing.
The market’s reliance on gigantic gains in just a few big winners — a concept known as skewness — offers ammunition for stock pickers to tout their skills and prove their worth. At the same time, adherents of passive investing say predicting future stars is nearly impossible and investors would be better off sticking to a simple buy-and-hold strategy on the broad market.
To Bessembinder, who works as a consultant to Scottish investment firm Baillie Gifford & Co., both approaches make sense and the choice boils down to one’s capability on stock picking.
“It would not be good if somebody had told LeBron James that the odds are stacked against him,” he said. Yet “for most individuals, this is not your comparative advantage.”
