After gaining more than $17 per share or 2.6% in yesterday's trading, Apple (ticker AAPL) is now the most highly valued company in history, sporting a market cap of $623.5 billion. Shares are now at an all-time high of nearly $665.
Most everybody knows about the story of the consumer electronics juggernaut, and how ubiquitous products like the ipod, iphone, or ipad have led to significant growth in sales and earnings. For instance, sales increased nearly 66% in fiscal 2011 while EPS gained 83%. Growth is also likely to continue, as the Street projects sales will increase by 44% in fiscal 2012 and 23% in fiscal 2013 while EPS is projected to 59% and 19%, respectively.
The question in my mind is will this growth translate into a higher stock price. I will be the first to tell you that I never looked at AAPL fundamentally and would be amiss to provide any insight. However, the market capitalization of AAPL does pose an interesting question, will trees continue to grow to the moon or put another way do significantly high market capitalizations stunt future stock performances. In my mind, the answer is yes. I have been around long enough to remember when companies like Microsoft (ticker MSFT) or ExxonMobil (ticker XOM) became the most richly valued companies in the world. I also remember their languishing share prices after each achieved this crown.
Now just because I recall a couple of companies that fit the mental model does not necessarily mean that the mental model fits reality. With that in mind, I thought it may be illustrative to see how the share prices of the ultra mega-caps performed relative to a broad base of stocks over the long-term. I created a screen looking at the market capitalizations of the current companies in the S&P 500 relative to U.S. GDP going back to the early 1970's. I arbitrarily chose two break points, companies with market caps equal to or greater than 0.5% and 1% of GDP. This screen sorted out a dozen or two names for companies with market caps over the 0.5% threshold and a handful of companies with market caps over the 1% level. Using this criteria, I created quarterly rebalanced portfolios, and assumed an equal exposure to each company in any one quarterly period, and calculated the average forward quarterly performance. For comparison purposes, I looked at the average performance, rebalanced quarterly, of the companies currently in the S&P 500 over the same time period. The graphical results are shown below.
The above graph shows the natural log of quarterly rebalanced portfolios with a starting point in the early 1970's. What is plainly obvious is that the average performance of the ultra mega-cap falls significantly short of the average stock performance of all companies in the S&P 500. It also appears that this effect is more pronounced as the market cap grows larger, as the stocks in the 1% group also underperformed the 0.5% subset. Why is this? My guess is that it is largely the law of large numbers. Ultra mega-cap names represent companies that are at the top of the game. They have grown strongly in past periods, and also likely dominate their industries. In addition, companies do not get this large without significant investor interest. Essentially, great companies do not necessarily translate to great stock performances.
What does this mean for AAPL shares? Could AAPL get to a $1 trillion market cap as some have projected? I really do not know, nor would I be comfortable making any forecast. I just do not know enough about the company's fundamental dynamics to make that call. That said, I think that the law of large numbers handicaps potential future stock gains in ultra mega-cap companies. If my goal was to beat some benchmark index, I would need significant evidence of either accelerating growth or some other catalyst not appreciated by the market to invest in these companies.
Most everybody knows about the story of the consumer electronics juggernaut, and how ubiquitous products like the ipod, iphone, or ipad have led to significant growth in sales and earnings. For instance, sales increased nearly 66% in fiscal 2011 while EPS gained 83%. Growth is also likely to continue, as the Street projects sales will increase by 44% in fiscal 2012 and 23% in fiscal 2013 while EPS is projected to 59% and 19%, respectively.
The question in my mind is will this growth translate into a higher stock price. I will be the first to tell you that I never looked at AAPL fundamentally and would be amiss to provide any insight. However, the market capitalization of AAPL does pose an interesting question, will trees continue to grow to the moon or put another way do significantly high market capitalizations stunt future stock performances. In my mind, the answer is yes. I have been around long enough to remember when companies like Microsoft (ticker MSFT) or ExxonMobil (ticker XOM) became the most richly valued companies in the world. I also remember their languishing share prices after each achieved this crown.
Now just because I recall a couple of companies that fit the mental model does not necessarily mean that the mental model fits reality. With that in mind, I thought it may be illustrative to see how the share prices of the ultra mega-caps performed relative to a broad base of stocks over the long-term. I created a screen looking at the market capitalizations of the current companies in the S&P 500 relative to U.S. GDP going back to the early 1970's. I arbitrarily chose two break points, companies with market caps equal to or greater than 0.5% and 1% of GDP. This screen sorted out a dozen or two names for companies with market caps over the 0.5% threshold and a handful of companies with market caps over the 1% level. Using this criteria, I created quarterly rebalanced portfolios, and assumed an equal exposure to each company in any one quarterly period, and calculated the average forward quarterly performance. For comparison purposes, I looked at the average performance, rebalanced quarterly, of the companies currently in the S&P 500 over the same time period. The graphical results are shown below.
The above graph shows the natural log of quarterly rebalanced portfolios with a starting point in the early 1970's. What is plainly obvious is that the average performance of the ultra mega-cap falls significantly short of the average stock performance of all companies in the S&P 500. It also appears that this effect is more pronounced as the market cap grows larger, as the stocks in the 1% group also underperformed the 0.5% subset. Why is this? My guess is that it is largely the law of large numbers. Ultra mega-cap names represent companies that are at the top of the game. They have grown strongly in past periods, and also likely dominate their industries. In addition, companies do not get this large without significant investor interest. Essentially, great companies do not necessarily translate to great stock performances.
What does this mean for AAPL shares? Could AAPL get to a $1 trillion market cap as some have projected? I really do not know, nor would I be comfortable making any forecast. I just do not know enough about the company's fundamental dynamics to make that call. That said, I think that the law of large numbers handicaps potential future stock gains in ultra mega-cap companies. If my goal was to beat some benchmark index, I would need significant evidence of either accelerating growth or some other catalyst not appreciated by the market to invest in these companies.
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