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Do mega companies offer mega opportunities?

Mega companies are bigger than most countries. Quite a few pharma, food, oil and tech companies reach annual revenues of over $50 bln, exceeding the GDP levels of more than 2/3 of the countries in the world. Unusually, these mega companies have performed better than the broad equity markets in the past 12 months.

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A rare phenomenon indeed, as their stock prices have almost continuously lagged the broad market since the late nineties. Is this the start of a new trend?

Between 2000 and 2011, megastocks were generally seen as losers. These slow moving giants were – and still are - among the favourite short-positions of hedge fund managers, who preferred to put their money to work in smaller companies. The equity performance of the latter tended to benefit more from the global economic growth or, after 2008, from the massive liquidity injections provided by central banks. However, with 2012 providing neither much growth nor significant injections by central banks, investors appear to once more have embraced the relative safety and inherent regional diversification of the megastocks.

In a world where growth is on the decline and uncertainty on the rise, this makes a lot of sense. It is not strange that equity investors shed their reluctance to pay a valuation premium for the low risk profile of megastocks at a time when fixed income investors are even willing to accept negative yields in bond safe havens. The large multinationals often pay relatively high dividends to yield hungry shareholders and at the same time fund themselves in the corporate bond market at rates of less than 1% over the extremely low treasury yields of countries like the US, the UK and Germany. This combination of factors has probably attributed significantly to the renewed interest in the equity mastodons.

However, one swallow doesn’t make summer and one can wonder whether the recent outperformance of megastocks is just a fluke. We think not. Of course, a potential restart of the printing presses in the US and Europe may cause more money to flow to the financial economy and may provide another temporary boost to risk appetite. But the marginal effect of these actions will probably diminish, as the seemingly endless expansion of Central Bank balance sheets always runs the risk of triggering inflation fears at one point. This is especially the case in the eurozone, where these actions mostly take place to counterbalance a persistent lack of competitive power in the southern part of this region.

Knowing this, it is likely that investors will maintain their preference for mega companies for a longer period. After all, these companies do not only offer regional (country + currency) diversification and strong balance sheets, but also provide their shareholders with a decent, and often growing, dividend income. In a world where liquidity injections are seen as the most suitable instrument to stimulate growth, real dividends from country-sized companies offer an appealing alternative for the ultra low nominal yields of money printing governments. So in equity markets, big may remain beautiful for some time to come.

Ad van Tiggelen , August 2012

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