COLUMN-In age of 'superstar firms,' index investing logic holds: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

May 29 (Reuters) - Even in the age of “superstar firms,” the logic of index investing holds.

New research details how a small number of companies - think Google, Amazon and Apple - have come to dominate their sectors, capturing a growing share of revenues and helping to create an economy featuring high corporate profits but a lower share of the pie for workers.

Economists David Autor, David Dorn, Lawrence Katz, Christina Patterson and John Van Reenen find that industries have become more concentrated and while what they call “superstar firms” pay well, they make extraordinary profits. The net impact across the economy, perhaps as other firms struggle to compete, is that workers’ share of GDP falls. (

Commentators have concentrated on the economic, social and policy implications of superstar firms but the investment ones are also interesting, and not obvious.

While you might think that the trick to investing in an economy with a few winners and many also-rans is to identify the Amazons and buy them, this, of course, is much more easily done looking backward than looking forward.

One problem is that the research finds that the concentration rises in industries with faster technological change. While fast technological change seems to bring big winners and concentration - see Facebook, it also brings with it the risk that companies will be supplanted by other technology in the future.

Indeed, one of the named superstar firms is Wal-Mart, which as a mostly physical retailer is now seeing its own position hollowed out by the likes of Amazon. Or consider IBM, which surely would once have been thought of as a superstar but which now is notable more for its fondness for share buybacks than its strong returns as a stock.

The reality is that a winner-take-all-society is a risky society, and that applies as much to investors as it does to college graduates or mid-career workers. It simply is not as simple as just figuring out who is ‘winning’ and climbing on board. A concentrated bet on superstar firms is very likely highly risky, not just in theory, as are all concentrated bets, but also in practice due to the rate of technological change.


Index investing, in contrast, will allow investors to be exposed to the rising, or persistently high, corporate margins which are a feature of a more highly concentrated economy. In other words, and sadly, the wise bet may not be on Amazon or Facebook, per se, but against labor.

While rising concentration and falling wages are new, it has long been a fact that the vast majority of the money made on the stock market comes via a tiny number of firms which skyrocket in value.

Hendrik Bessembinder of Arizona State University calculated in a recent study that just 86 stocks have, over 90 years, accounted for $16 trillion in wealth creation, or about half the total of wealth created by the entire universe of companies over that period.

The other 26,000 or so stocks created the other $16 trillion of wealth, but even that is a misleading guide to how well an individual stock might do. The top 1,000 stocks, or less than 4 percent of all companies traded over 86 years, account for all wealth creation.

“The results also help to explain why active strategies, which tend to be poorly diversified, most often underperform,” Bessembinder wrote in a draft study updated in May. (here)

It is notable too that superstar firms have risen, and wages fallen, during a period with rising globalization and a political and regulatory backdrop which allowed it to happen. It may well be that Google, Amazon and Facebook face new political and regulatory roadblocks to maintaining their position. This certainly is already true in China.

So your choices boil down to these:

1 - Try to identify some of the 86 superstars in advance. Good luck with that.

2 - Buy stocks you think are among the 86 after they so prove and hope they hold their position. This strategy misses out on all of the gains these few superstar firms make before it dawns on you they’ve arrived. It also exposes you to huge risks that they are in turn supplanted.

3 - Buy a broad stock market index, including earlier-stage companies, and slowly build wealth by collecting the equity risk premium and allowing it to compound.

The logic of choice 3 should hold as the balance between profits and labor evolves. (Editing by James Dalgleish) )