The Danger in Buying the Biggest

 | Apr 22, 2013 | 2:03 PM EDT
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There's a common belief that a big company is always the safest place to park your money.

There's certainly no denying that size has its advantages in investing. Multiple lines of business, geographic diversity and deeper financial resources are all things that prove valuable in tough environments. But I would argue that despite these undeniable benefits to size, it can be quite perilous to your portfolio to owning the biggest companies.

It's a mathematical fact that the biggest companies by market cap are companies that are:

  1. Widely held by the investing public
  2. Viewed with the highest degree of optimism.

After all, how else can a company have the largest market capitalization? In trading parlance, such a company is often in overbought territory. Math also tells us that as a market cap expands, it takes more and more money to move the needle.

Yes, you knew this was coming next, but Apple (AAPL) is today's current scapegoat. To say that Apple was overbought is an understatement. Last year, articles were coming out about individuals whose entire retirement nest eggs were in Apple. Since assuming the throne of biggest company, Apple shares have shed nearly 50% of their market value.

Apple has given the title back to ExxonMobil (XOM), which has a market cap of nearly $400 billion. For the past 12-month period, XOM share are up 2% vs. nearly 15% for the S&P 500. Below is a list of the companies that held the top market-cap spot at beginning of the year for the past past five years. In parenthesis is the return that company generated that year (rounded for simplicity).

2013: Apple (so far in 2013, down 29%)

2012: Apple (2012 return up 27%)

2011: ExxonMobil (2011 return up 16%)

2010: PetroChina (PTR) (2010 return up 5%)

2009: ExxonMobil (2009 return down 10%)

2008: ExxonMobil (2008 return down 18%)

If you were to examine the returns for greater than a one-year period, the trend gets worse. For examples, Exxon's 5-year return is -5.4% vs. +11% for the S&P. If Apple shares remain where they are today at year end, then all the gains of 2012, plus some of 2011, would be wiped out. The best time to have bought Apple was clearly when it was nowhere near becoming the biggest company in the world.

So, size is not all that it's made out to be in investing. Being the biggest can be a very dangerous thing from a future return perspective.

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