Largest firms face obstacles

by Russ Wiles, columnist The Arizona Republic Jun. 13, 2010 12:00 AM

With all eyes now focused on the World Cup, one thing seems certain - the eventual winner will be Brazil, Argentina or one of the half-dozen European powerhouses.

Big clearly is best on the global soccer stage, as it has been in every tournament since little Uruguay won it all in 1950.

The same description doesn't necessarily extend to the business world and the stock market, where the top companies don't always fare so well.

The past few years have been horrible for several once-invincible corporations including General Motors, Toyota, Bank of America, Citigroup and now BP.

Are the setbacks sustained by these giants mere coincidences, or do bad things tend to happen to industry leaders?

In a warning that's worth heeding by investors, Robert Arnott, a money manager at Research Affiliates in Newport Beach, Calif., makes an interesting case for the latter.

"When you're No. 1, you have a bright target painted on your back," he wrote. "Indeed, in a world of fierce competition and serial witch hunts in Washington, that bull's-eye is probably painted on your front and sides, too."

Arrows get launched from competitors, politicians and pundits. The public favors underdogs and calls for your head.

"Hardly anyone outside of your own enterprise is cheering for you to rise from world-beating success to still-loftier success," Arnott wrote.

He cited other examples, including Goldman Sachs (now facing fraud charges), Exxon Mobil (regularly accused of making obscene profits), Microsoft (a target for monopolistic practices) and AT&T (broken up years ago for the same reason).

"The very business practices that propel an organization to No. 1 - aggressiveness, focus, canny outmaneuvering of the competition - become unacceptable if you're wearing the yellow jersey," Arnott wrote.

Many investors pad their portfolios with the shares of industry-leading companies and, in fact, often consider that the safe thing to do. Yet such behavior can be hazardous.

Arnott tracked the "top dogs" in 12 industry sectors over 58 years and noticed these firms tend to lag in the stock market.

"We find the leader in any sector underperforms the average stock in its own sector by 3.5 percent in the next year and the next year and the next year," he wrote. "The damage doesn't really slow down for at least a decade."

The top stocks in those 12 market sectors lost 28 percent in relative value, compounded, compared with the average stocks in their groups.

"For investors, top-dog status is dismayingly unattractive," Arnott wrote.

Some other findings from his research:

• Top dogs tend to get booted out by new leaders over time, with the notable exception of the energy field, where Exxon Mobil continues in the legacy of primacy once enjoyed by Standard Oil.

• Top dogs tend to fare better during Republican administrations, when politicians are less focused on regulation and less likely to demonize success.

• Investors should consider stripping their portfolios of industry leaders or at least paring back their exposure.

Many knowledgeable investors recognize that small- and mid-sized stocks, along with their heightened volatility, have delivered better long-term appreciation than big companies. However, the analysis hasn't tended to compare the very top dogs against everyone else.

Since 1926, large stocks in general have averaged a 10 percent annual growth rate compared with 11.9 percent yearly for small stocks, according to researcher Ibbotson Associates.

Traditional explanations for this performance gap include the fact smaller firms often are more nimble, more entrepreneurial and less bureaucratic than their larger rivals, and they can generate bigger percentage profit gains from each new dollar of revenue.

But Arnott's research suggests there's more to it than that, with big companies also needing to spend a lot of time, energy and money defending themselves in an increasingly hostile world.


Largest firms face obstacles