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Here’s Why Big Companies Getting Bigger Might Be a Problem for the Entire Market

0 | By Shah Gilani

A lot of investors don’t buy big companies’ stocks because they don’t believe the companies can get any bigger than they are now. They’re wrong. They’ve been wrong. And they’ll continue to be wrong.

Just because a company is gigantic, maybe weighing in with a trillion-dollar market capitalization, it doesn’t mean it can’t get bigger and its stock can’t keep making higher highs.

As long as companies can grow their revenues and profits, their stock prices are going to go higher too.

But that doesn’t mean there aren’t problems with big companies’ getting bigger or their stocks soaring.

There are certain patterns you need to look out for when you’re thinking about investing in one of them.

And that’s what I want to show you today.

Here’s what’s working for big companies getting bigger and the problem with their stocks skyrocketing.

Big Is Beautiful

Take Apple Inc. (AAPL), Microsoft Corp. (MSFT), and Amazon.com Inc. (AMZN), for example. They’re gigantic. In fact, they’re so big investors wonder if it’s possible for them to grow enough to warrant holding them as opposed to looking for real “growth” stocks.

But they are growth stocks.

Despite their size, market saturation, and every other metric, naysayers say they can’t keep growing and mistaken analysts and investors are being proven wrong quarter after quarter, year after year.

Apple’s market capitalization, meaning its equity value, is about $1.4 trillion. Microsoft weighs in at $1.3 trillion. And Amazon just joined the trillion-dollar club (again) today, when it’s much better-than-expected earnings lifted the stock $153 a share, as I write this at 10:00 am today.

Apple hit it out of the park on Tuesday when it released its earnings.

Revenues were up 9% to $91.8 billion, a record for the quarter. Earnings per share were up to $4.99, another record. Even iPhone sales, the soft spot analysts and investors feared would decline after being the engine of Apple’s growth and sink its future, rose 8% to a whopping $55.76 billion for the quarter.

And if anyone thought Apple’s stock was overvalued a year ago, guess what? It almost doubled in a year, adding $700 billion to its market capitalization.

Microsoft’s earnings, which came out on Wednesday, were insane for an “old” company. Only foolish analysts and investors don’t know “growth” is Microsoft’s surname.

Revenue at Mr. Softy was up an insane 14% to $36.9 billion in the quarter and profit was up an even crazier 38% to $11.6 billion. Earnings per share came in 40% ahead of EPS a year ago, beating analysts’ estimates of $1.32 per share by 15%, or $1.51 per share.

Show me a company as old as Microsoft that IPO’d in March 1986 and is growing like, well, a growth stock, 34 years later? There isn’t one.

Today Amazon reported earnings for its latest quarter.

Talk about growth!

Amazon just posted record fourth-quarter sales of $87.4 billion. That’s 20% higher than its revenue a year ago. Profits for the quarter trounced analysts’ expectations coming in at $3.3 billion.

Earnings per share for the quarter were insane, hitting $6.47 per share, a whopping $2.47 or 61% higher than analysts’ estimates of about $4.

How’s that for growth?

But It’s Not Just About Apple, Microsoft, and Amazon

It’s not just these standouts that matter. Facebook Inc. (FB) matters. Alphabet Inc. (GOOGL) matters. Netflix Inc. (NFLX) matters.

Big companies are getting bigger because they’re growing their customer bases, growing their reach, their ecosystems, growing their product and service offerings, growing their revenues, growing their profits, and growing their cash hoards.

It’s all good. Until it isn’t

The only problem, actually there are two problems, is these giant’s stock prices are getting bigger.

On an individual basis, as long as the big companies keep growing their earnings, their sometimes-inflated price-to-earnings multiples (PE ratios) get lowered as the earnings portion of the ratio increases, catching up to the price or exceeding the rate of growth of the stock’s price increases.

If the big tech stocks leading markets higher become too pricey and their earnings start to slow, there’s likely to be a correction that brings inflated “valuations” and ratios back to more normal trend levels.

The bigger problem these big and getting-bigger companies pose to the market and themselves is their bigger and bigger stock prices make them bigger and bigger components in indexes they’re in.

In capitalization-weighted indexes like the S&P 500, the bigger the market capitalization a stock has, the more its weight carries in the whole index. In other words, it becomes the prime-mover in the indexes where its cap-weight is big and getting bigger.

The same is true for all the big stocks mentioned here. They have essentially become “the market.”

If they keep growing, it’s all good.

Just beware of correction talk and a possible selloff if a few of the leadership stocks, the big-cap growth stocks, start to slow down.

Or, if for whatever reason, they see selling pressure hit their stock prices and start slipping for no good reason.

Then, and probably only then, it’s time to take cover.

Sincerely,


Shah

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