Why Apple investors should remember Nortel
If history is any guide, Apple Inc. is too big to be a good investment.
If you doubt that, consider the rise and fall of Canada's very own Nortel Networks Corp.
At its highs, Nortel represented more than 40 per cent of the S&P/TSX 60 index. Its fall from grace was unusually severe.
Thankfully, most giant companies don't implode quite as spectacularly as Nortel, but the stocks with the biggest market capitalizations tend to disappoint shareholders nonetheless.
A new study by money manager Robert Arnott and his colleague Lillian Jing Wu, The Winner's Curse, puts numbers on the disappointing track record of the biggest stocks in the world.
Mr. Arnott and Ms. Wu examined the largest stocks in the United States, by market capitalization, from 1952 to 2011. Seven different firms held the top spot over the period and their performance was, on average, pitiful.
If you had invested in the largest U.S. stock, you would have underperformed an equally weighted index of U.S. stocks by 3.7 percentage points a year, on average, over the following decade. The results were even worse on shorter time scales. The largest stock underperformed by an average of 4.2 percentage points over one year, 4.5 percentage points over three years, and 4.1 percentage points a year over five years.
We can debate why this happens, but it's clear that highly successful firms tend to attract a slew of competitors eager to take a bite out of their business. Such competitors are usually smaller and nimbler than the giants, and may exploit niches the biggest firms are loath to contest.
In Apple's case it is already beset by competitors, from Google Inc. and Samsung Electronics Co. Ltd. in the smartphone market to Amazon.com Inc. and Microsoft Corp. in the tablet business. (Mind you, Microsoft is itself a poster child for the too-big-to-succeed thesis.)
Apple's plight is similar to that of market leaders in every major country. While investing in the biggest stock in the market has been a bad idea in the U.S., it has been an even dimmer idea in other locales. Between 1982 and 2011, the largest stocks in the G8 nations underperformed their local markets by a shocking 4.7 percentage points a year over the subsequent decade, according to Mr. Arnott and Ms. Wu.
In Canada, the situation was particularly dire - thanks, in no small part, to the demise of Nortel. The largest Canadian stock underperformed by 17.7 percentage points a year, on average, during the decade after purchase.
While it's not impossible to outperform by investing in giant stocks, history shows the odds are stacked against you in the vast majority of industries.
Mr. Arnott and Ms. Wu looked at the performance of the largest G8 stocks in each sector. The worst performances were to be seen in the business equipment, telecom, manufacturing, and durables sectors. On the other hand, the non-durables and energy sectors showed relatively mild underperformance over the decade after purchase.
Given Canada's particularly poor track record, it is instructive to see which firms are the largest in the land. They can be found in the accompanying table, courtesy of Capital IQ. (Note that Capital IQ defines sectors slightly differently than Mr. Arnott and Ms. Wu.)
So should you rule out buying Apple because of its enormous size? Despite the generally dismal record of giant stocks, I'm not entirely sour on the Cupertino, Calif., giant. After all, its shares have already fallen more than 25 per cent from their all-time highs. The firm also has a huge pile of cash, remains fabulously profitable, and appears to be reasonably priced based on its low price-to-earnings multiple.
There is a chance it'll be an exception to the rule. But you should know the odds against it before investing.
First published in the Globe and Mail, January 13 2013.
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