Think The Biggest Companies Of The S&P 500 Will Outperform? History Says Otherwise

August 4, 2017

Think The Biggest Companies Of The S&P 500 Will Outperform? History Says Otherwise

  • The strongest companies in the S&P 500 may look invincible now, but history shows us this won’t last forever.
  • None of the companies in the S&P 500’s 1980 top 10 are still there now.
  • Top 10 S&P 500 companies largely underperform the S&P 500 in the long term.

Introduction

Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN), and Johnson & Johnson (NYSE: JNJ) are the 5 largest holdings of the S&P 500 accounting for 11.74% of the index. The other 495 companies account for 88.26% of the S&P 500 which is a pretty strong imbalance, but that’s how the S&P 500 is formed. Its weightings are based on market capitalization. The bigger the market capitalization, the bigger the weighting in the index.


Figure 1: S&P 500 Top 10 holdings. Source: iShares.

The market capitalization of a company increases as more and more investors put faith in the stock and its price increases. That’s usually because investors think those stocks are so good that they carry little risk, and because their current earnings are strong.

What I find interesting is investigating how the top 10 S&P 500 holdings have changed over time to determine the actual risks that the companies with the largest global market capitalizations carry. Let’s start with the 1980s.


Figure 2: S&P 500 holdings in 1980. Source: ETFDB.

In 1980, the leaders were IBM (NYSE: IBM) and AT&T (NYSE: T) followed by an array of oil companies. Let’s see how those companies, which were thought to be the future global leaders, have performed against the S&P 500 since 1980.


Figure 3: Top 4 S&P 500 companies from 1980 against the S&P 500. Source: Yahoo Finance.

Only Exxon Mobile has performed as well as the S&P 500 while the other 3 companies significantly underperformed the S&P 500.

Let’s look at what the results are from the 1990 S&P 500 top holdings.

The first thing to note is that only four companies from the top 10 in 1980 were still in the top 10 in 1990: IBM, XOM, T, and GE.


Figure 4: S&P 500 top holdings for 1990. Source: ETFDB.

From a performance perspective, with the exclusion of Philip Morris—due to the Philip Morris International spinoff—none of the other 4 companies at the top of the S&P 500 list in 1990 have outperformed the S&P 500 since then.


Figure 5: S&P 500 top 4 holdings since 1990. Source: Yahoo Finance.

Let’s look at how the top holdings performed from the year 2000.


Figure 6: S&P 500 top holdings in 2000. Source: ETFDB.

As was the case for 1980 and 1990, just 4 companies from the previous 1990 top 10 holdings remained in the top 10 in 2000.

As for their performance, we have finally one company out of the top 5 that outperformed the S&P 500 since 2000, that is XOM. However, the other four companies significantly underperformed, especially when you consider that Citigroup is down 82%, General Electric 49%, and Cisco 41%.


Figure 7: Top 5 S&P 500 holdings performance since 2000. Source: Yahoo Finance.

What’s left then is to check out how things have evolved since 2010. Again, only 4 out of the top 10 holdings from 2000 remained in the top ten.


Figure 8: S&P 500 top holdings for 2010. Source: ETFDB.

As for the performance, we finally have 3 outperformers. AAPL which has gone up 416% since 2010, Berkshire Hathaway with 167%, and Microsoft with 132%, which is better than the S&P 500 and its 118%. XOM is up 16%, while GE is up 65%. For the first time, though the calculations were for 7 years only, the top 5 companies outperformed the S&P 500.


Figure 9: Top 5 stocks since 2010. Source: Yahoo Finance.

If we compare the current S&P 500 top 10 holdings to the 2010 top 10, only 5 companies have remained in the top 10.

Current Situation

All of the above brings me to the conclusion that the strength and robustness the market tends to attach to the top companies in the S&P 500 is something that quickly fades. If you consider a decade quick, that is.

Only Exxon, and that’s mostly thanks to the merger with Mobil, has remained in the S&P 500 top 10 since 1980. On top of that, as you can see in the performance charts above, rarely does a top 5 company outperform the S&P 500 in the long term. This is because up to certain level, the scale large companies reach is positive, but after that, it becomes a weight. Every competitor is going after Amazon, Apple, Facebook, Microsoft, and Johnson & Johnson which makes it very difficult to remain consistent and have high margins and growth for the long term, where I consider the long term more than a few decades.

Let me describe a few of the still unrecognized market risks for each of the top 5 S&P 500 stocks by comparing them with past situations.

Let’s start with Apple which is at the top of the current list. It’s an information technology company and of an unmatched profitability at the moment, similar to what the case was for IBM in 1990 when IBM was dominating the field.


Figure 10: IBM’s market position was unmatched in the 1990s. Source: Arstechinca.

Apple’s current mobile phone position isn’t even as strong as IBM’s 1990 position. AAPL’s share price depends completely on current earnings and if sales drop in the next few years, the stock price could quickly follow.

Microsoft has become the standard, but revenue growth hasn’t really been stellar in the past few years indicating that it needs to reinvent itself to grow. Which is something that will be very difficult with all the competition out there.

Amazon’s biggest challenge are margins. Every retailer is investing heavily in e-commerce and it’s extremely difficult to be profitable. The latest miss in earnings due to higher CAPEX indicates how much investment is necessary to stay ahead of the competition with questionable future profitability.

As for Facebook, let me just give you a list of past market dominators: America Online, Yahoo, Excite, Netscape, GeoCities, Alta Vista. How many of those still exist? None.

As for Johnson & Johnson, the company hasn’t seen much growth in the last 10 years with less than two percent per year. This shows how difficult it is to grow from such a high level and leads to the conclusion that to outperform the S&P 500 in the long term, one must not look to the largest companies.

Conclusion

The issue is that many quickly forget that the environment we take for granted usually quickly changes in unforeseen ways. The business models that are expected to dominate the world for eternity show flaws, the competition intensifies, or a new company disrupts the market. I’m not saying that the S&P 500 ranking will change tomorrow, I’m just saying that each investor should know the risks and how similar stocks have behaved in the past.