Think Twice about Chasing the Biggest Stocks

As companies grow to become some of the largest firms trading on stock markets - what we commonly call Blue Chip stocks - the returns that push them there can be impressive.  Many investors are attracted to these stocks with the expectation these strong returns will continue indefinitely.

But research shows not long after joining the Top 10 largest stocks by market capitalisation, these stocks, on average, lag the market.

Looking at the U.S stockmarket from 1927 to 2022, the average annualised return for these stocks over the three years prior to joining the Top 10 was almost 27% higher than the market. The stocks had clearly been high performers.

However, in the five years after becoming a Top 10 stock, these stocks were, on average, underperforming the market by -0.9% pa – a stark turnaround from before.

These outcomes are illustrated in the following diagram:

The gap was even wider 10 years out, with these stocks underperforming the market by 1.5% per annum.  It means after 10 years, these stocks had underperformed the market by around 15%.

In the U.S, Intel is an illustrative example. The technology giant posted average annualised excess returns of 29% in the 10 years before the year it ascended to the Top 10 largest stocks but, in the next decade, underperformed the broad market by nearly 6% per year. Similarly, the annualised excess return of Google five years before it hit the Top 10 dropped by about half in the five years after it joined the list.

In Australia, think of CSL in early 2020.  In late February 2020 it surpassed CBA to become Australia’s largest listed stock.  The CSL share price had risen 58% in the preceding 12 months! There were many investors who decided to jump on the CSL bandwagon at that point. Since then, CSL has underperformed the ASX 300 by 22.3%, with the share price down 15%.

Investors should be mindful of these dynamics and recognise that past performance is not always indicative of future results. Diversification and a long-term investment approach remain crucial strategies for managing risk and achieving investment objectives in the stock market.

Author: Rick Walker