[07/30/19] Will Growth Stocks Continue to Perform and Value Stocks to Disappoint?

   If you wondered whether high valued growth stocks, including high tech and internet services providers, will continue to perform well, and low-valued stocks to disappoint, read the following article by me and colleagues (listed at article end) describing the results of our recent extensive research.

Elephants Can’t Dance? Revisited

Large firms seem better prepared to weather challenges from small companies than in past

            Literature is replete with the idea that large companies can’t innovate and the ongoing digital revolution would put many large companies on the verge of extinction. This idea is supported by headlines announcing the closures of prominent stores such as Borders, RadioShack, and Macy’s. Numerous startups of the last thirty years have not only disrupted businesses but have become the megacorporations of today. We examine the idea that the ongoing digital revolution must be accelerating the demise of large corporations. The purpose of this article is not to dispute the notion that technologies such as digital have disruptive potential but to examine its time trends. In particular, we examine whether large established corporations leverage digital and other technologies to innovate and grow or whether their businesses are increasingly disrupted and decimated by new technologies. Contrary to the popular notion, we find that large corporations are more and more likely to maintain their dominant positions, while small corporations are less and less likely to become big and profitable. This growing corporate divide between big and small firms is aided by the growing R&D expenditures of large firms. Our results support Lou Gerstner’s thesis that the elephants are not basking in their past glory, but can indeed dance and are becoming nimbler at it.

We chart below the annual, inflation-adjusted difference between the median market values of the 30% largest companies and the 30% smallest public companies. It is evident that from the mid-1990s, the size difference between the large and small increased continuously and rapidly, except for the recession years of 2008-2009. This gap, in 1981dollar value, reached almost $3.5 billion in 2017. In 2017 dollars, this gap amounts to $8.8 billion. Since we examine median values, this difference is not driven by the runaway success of a few companies like Apple and Amazon. We also examine the large and small companies separately. We find that the former are getting bigger while the latter largely stagnate.


The performance gap between the large and small increases too. The difference in median return on operating assets was 15% in the 1990s, doubling to 30-35% recently; an enormous performance gap. Inspecting the two groups separately clarifies that the large companies are getting more profitable, whereas the small ones suffer from chronic unprofitability. In fact, both the median return on operating assets and the median profit margin of the small companies turned negative during 2015-2017. Moreover, the gap in the fraction of companies reporting annual losses widened too: while 10-15% of the large companies reported annual losses in recent years, the loss frequency of the small companies became ominous 60-65%. So, almost two-third of small companies can’t cover their expenses, despite the booming economy. The widely touted nimbleness and creativity of small enterprises isn’t evident in the data.

We examine the main driver of enterprise performance and growth: the rate of investment in tangible, and particularly intangible (R&D, brands, technology, human resources, etc.) assets, and find a dramatic increase in intangibles investment differences. The chart below shows, for example, that the difference between the mean annual R&D spending of large and small companies grew from less than $20 million in the 1980s to almost $120 million in 2017 (inflation adjusted to 1981 dollars). On average, a large company spent 330 million on R&D in 2017, while the average small company spent a paltry $6 million, obviously insufficient keep pace with a large competitor, except through a fortuitous discovery.


A similar pattern of a growing divide exists for SG&A (sales, general and administrative) expenses, which often include intangibles spending, such as on IT, brands, human resources, and unique business process. Clearly, large firms have increased their investments on innovation and intangible expenditures and are not basking in their glories. For example, large retail firms and banks are capitalizing on advancements in artificial intelligence to aid their legacy operations.

“That’s all normal” will say the naysayer. Amazon, Netflix, and Microsoft were, once upon a time, small companies too, but grew to be large and dominant. Many of the currently small companies will surely fare similarly. So, what’s the problem? The problem lies in the most surprising of our findings: the small size trap. Simply stated, it becomes harder to “escape” the class of small companies. Whereas, until 2000, 15% to 20% of small companies escaped their group each year, this percentage was cut by half by 2017. We find similar evidence in the large size category. Until 2000, 75% to 80% of large companies remained in their group next year, that percentage increased to 89% recently.

A different measure of group stickiness―the correlation between a company’s size rank with that of the last year. The higher the correlation, the greater the likelihood that a small company remained small and a large company remained large. This correlation increased over time, most notably for small companies, for which it now stands at 90%. Stated differently, if you were a small company in the previous year, you are increasingly likely to remain a small company now.

Thus, the natural process of small companies growing organically to capture dominant positions (Microsoft, Amazon, Netflix, Amgen, Oracle, Cisco), typical of the 1980s and 1990s, seems more and more difficult. In contrast, large companies seem less likely to yield their dominant positions. On one hand, it is good news that large companies are innovating and maintaining their dominant positions through innovation, scalability, and first mover advantage. On the other hand, the fact that smaller companies are increasingly likely to be excluded from the growth does not bode well for an economy that has led the world over the past century by virtue of creating global corporations based on ideas and entrepreneurial pursuits.

What’s a manager of a small firm do to escape the small size trap? And what can a manager of large firm do maintain its dominant position? We constructed a statistical model to distinguish between companies that remained small versus those that escaped this class. We find that escapees had a substantially higher investment in intangibles, larger debt raised (to finance investment), and fewer annual losses than the perennially small. Escapees were also larger and younger than those left behind. Notably, investment in physical assets (property, plant, equipment), share buyback, dividend payments, and acquisitions were negatively associated with the likelihood of escape. We also constructed a model to distinguish between the companies that remained large versus those that dropped down from this class. The significant factor aiding the success of large companies were investments in intangibles and physical assets, share repurchases, dividend payments, and length and size of dominant position. While there are significant differences between the success factors for large and small firms; yet, a common theme is intangible investments.

In sum, we find waning evidence for the idea that large companies do not innovate and that their business will soon be disrupted by small firms. The investment and growth opportunity set of small companies is shrinking, and their nimbleness and grit is increasingly under pressure. In contrast, the large companies are thriving, investing in innovation and intangible assets at an increasing pace, and seem better prepared to weather challenges from small companies than portrayed in literature.


Vijay Govindarajan is the Coxe Distinguished Professor of Management at Dartmouth’s Tuck School of Business. He is a coauthor, with Ravi Ramamurti, of Reverse Innovation in Health Care: How to Make Value-Based Delivery Work (Harvard Business Review Press, 2018).

Baruch Lev is the Philip Bardes Professor of Accounting and Finance, Stern School of Business, New York University. He has written six books, including his recent The End of Accounting and The Path Forward for Investors and Managers (2016), and published over 100 research studies on investment and economic analysis.

Anup Srivastava holds Canada Research Chair in Accounting, Decision Making and Capital Markets and is an Associate Professor at Haskayne School of Business, University of Calgary. He examines the valuation and financial reporting challenges of digital companies.

Luminita Enache is an Assistant Professor at Haskayne School of Business, University of Calgary. She investigates financial disclosures of new-economy firms.


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