In an across-the-board great year for equities, small-cap and value stocks outperformed in 2013 to the point that even Apple Inc. (NASDAQ:AAPL) starting showing up on some analysts lists of ‘value stocks’. Simple regression to the mean arguments would argue in favor of large-cap companies in 2014, but the growth of activist shareholders and the money flow story give investors more reason to be interested in large domestic firms.
“History is not always a perfect guide, but a variety of factors argue convincingly for large caps over their smaller cap counterparts after several years of small cap outperformance,” writes Citi analyst Tobias M. Levkovich. The largest 25 companies on the S&P 500 (INDEXSP:.INX) are trading at about a 10% discount relative to the index as a whole, and small-caps in general have a higher PE multiple than you might normally expect.
Shareholder activists taking on Mega-Caps
A similar argument could be made about European equities, but shareholder activists create a very real difference between the two markets. “We suspect that the US experience may be a bit different given the rise of shareholder activists who have challenged the boards at companies including Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), DuPont Fabros Technology, Inc. (NYSE:DFT) and The Procter & Gamble Company (NYSE:PG), with most management teams now worried about such developments,” writes Levkovich. This trend is mostly confined to the US because “many large international entities (often with meaningful government ownership) can withstand outside agitators in a way that is not found in America.”
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The raises the prospect for dividends (or buybacks) beating expectations, especially from companies like Apple Inc. (NASDAQ:AAPL) that have plenty of cash on hand.
New investors tend to invest in known brands
The other factor that benefits large companies is that they lay the best claim to the money flow story that is being pushed around. Most of last year’s price growth was a result of multiple re-rating as investors re-evaluated companies’ long-term potential in light of a recovering economy, but re-rating growth has mostly played out, leaving most companies to focus on earnings.
But the stock markets’ high profile rise will probably attract new investors to the market. “We suspect, given some historical guidance, that [new investors] will go for larger better known entities than try satisfying their newfound willingness to buy equities via speculation in smaller companies whose names they have never heard,” writes Levkovich.
If a new group of relatively inexperienced investors does start putting money into the market, and specifically into the large companies that dominate financial news headlines, there could be room for further multiple expansion among large caps.