About a year and a half ago I wrote and article investigating the performance of the largest public stock by market capitalization each year.
The original study was featured in the book “Mosaic: Perspectives on Investing” by Pabrai.
Pabrai did a backtest and reported a near 500 bps underperformance for the top mkt cap company vs the S&P 500. I extended the study a few years and found the results to be consistent, with the underperformance in CAGR of almost 7% from 1986-2006. This intuitively makes sense as the forces of capitalism work to compete with the top company (in addition to the difficulty in growing earnings at a massive scale).
How did this strategy perform in 2007?
Awful. Exxon’s stock (XOM) was up about 24% vs. 5.5% for the S&P 500. XOM would have been the largest company again in 2008, and both XOM and the S&P are down about equally in 2008.
Bespoke takes a look at the top companies in the world by market cap and 2008 stock performance.
PS One of the topics Pabrai covers in a subsequent book is cloning the best investment processes of great investors such as Buffett, Graham, and Munger. He argues that there is no need to reinvent the wheel – and simply apply the same selection model these investors have for decades. I go a step further and argue that an investor can perform equally well by simply following the holdings of these investors.
I have no idea how Pabrai’s funds are performing, but if he is just running a long only book, then it sure looks like he is in trouble (from SEC filings). I don’t see him on the implode-o-meter list…
The underperformance of the top stock or stocks by capitalization is a powerful argument for Bob Arnott’s Fundamental Indexing approach. Among US large-caps, FI claims to offer a historical edge of more than 200bps per year versus conventional indexing, mainly because of this underperformance effect.
j’adoube
Which suggests a possible strategy: long a fundamental index, or maybe the equal-weight S&P 500, short the actual S&P. And Mebane here is the perfect person to look into this trade's performance.
Dennis,
I don’t think this would make sense. This strategy would only have an expected return of the differential between the returns of the fundamental index versus the cap weighted index, which Arnott and others suggest is only 200 to 250 basis points.
OK, how about with leverage?
Different point of view from that post. Interesting to say the least.