In investing, however, it’s often a good idea to resist temptation. In fact, there’s still an investment case for bigger stocks.
Let’s start from an overlooked fact – that it is incredibly rare for companies to get very big: according to the ONS, only 0.12 per cent of the 2.17 million firms in the UK have more than 1000 employees. This tells us that there are massive barriers to growth. The very fact that a tiny handful of firms have overcome these suggests that they are doing a lot right. (Though whether this is by skill or luck is another matter!) This in turn implies that they have the qualities to survive many shocks, and to grow more.
And, remember, diseconomies of scale are only part of the story. There are also economies of scale and advantages of path-dependence. Big firms have a lower cost of capital, brand power and more scalability than smaller ones.
All of this helps explain one of the key facts about company growth. It’s Gibrat’s law – the fact that growth is independent of size; big firms are as likely to grow as small ones.
It’s a matter of debate how true this law is. Two facts, however, suggest it isn’t far wrong. One is that if big firms tended to shrink relative to smaller ones, then we would by now have a flattish corporate ecology with no massive firms and little monopoly power. But this, of course is not the case.
The other fact is that returns on big firms, over the long run, are pretty similar to those on smaller ones. In the last 20 years, for example, the FTSE 100 has returned 7.3 per cent a year against 6.9 per cent for the FTSE small cap index.
However, there might be a reason to favour bigger firms now. If we really are in an era of secular stagnation, then they should benefit. Slower technical progress should mean that they face less threat from disruptive technologies which render their vintage capital obsolete. And it should also mean that small caps won’t benefit from euphoric growth expectations; one feature of the tech bubble of 1999-2000 is that smaller stocks out-performed the FTSE 100.
What's more, mega caps are not especially risky. Sure, they contain high-beta banks and miners. But they also include defensives such as Glaxo, Vodafone, National Grid and BAT: mega-caps actually out-performed small caps during the 2008-09 crisis, despite containing the banks. In this sense, a bet against mega caps is a bet on the market doing well.
Now, whilst it is that time of year when this bet usually pays off, history warns us that such a bet is risky because investors often overpay for the growth which they erroneously believe smaller firms offer; this is one reason why Aim has consistently underperformed since its inception.
Sure, big stocks aren’t a “get rich quick” investment. But nor are they a “get poor quick” one.
But what about Tesco? Doesn’t its big fall remind us that big stocks are dangerous?
Only partly so. In the last 12 months, Tesco has fallen 54 per cent. During this time 174 of the 1952 shares in the IC’s stock screen database have done even worse – that’s 8.9 per cent of the total. Tesco’ troubles have got all the attention. But there have been many bigger disasters among smaller firms.
