Why (some of) the Big Get Bigger

By Jonathan Scheid
 17-Jul-1510-Jul-15Weekly% ChangeYTD% Change12 month %Change
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On Friday, two individuals saw their combined net worth increase by over $8 billion (source: Motley Fool). These two individuals, Sergey Brin and Larry Page, are the co-founders of search engine giant, Google. The gains were a result of better than expected second quarter performance and a commitment to be smarter with how they spend their money to achieve growth especially when it comes to their moon shot projects like self-driving cars and drone delivery services.

Shareholders of Google also saw their wealth go up as the company’s stock gained 16% in a single day (please note: there are two share classes of Google stock: GOOG and GOOGL). That equated to a single day market cap increase of $65.1 billion according to data compiled by Standard & Poor’s. It was easily the largest single day wealth creation increase for a publically-traded company.

While the one day numbers are impressive, Google has been subject to the challenge known as the law of large numbers. For investing, this law suggests that it is harder for large companies to post high growth rates because they are working from a larger base. For example, it is far easier for a $5 billion company to grow in size by 50% than it is for a company like Google with a market capitalization well over $400 billion. In fact, we saw this phenomenon play out for Google over the last year as their stock essentially moved sideways as the broader market advanced.

Yet, the internet services sector has turned into a winner takes most market, making higher growth rates more obtainable. For example, of all the internet searches that take place through desktop computers, approximately 64.4% of them are done using a Google search tool (source: comScore qSearch as of January 2015). Additionally, the internet has no real boundaries. Internet companies don’t have to open shops and store fronts in major markets to grow their revenue like restaurants, retailers, grocery stores and hotels, and that helps them get bigger faster.

Another popular way to get bigger among companies is through mergers and acquisitions. In the technology industry, this is a fairly standard way of growing and enhancing products. This also surely applies outside of the technology space and we are seeing increased merger and acquisition activity as companies look to increase revenue growth rates and increase their stock price.

Earlier this year, Charter Communications agreed to acquire Time Warner Cable for $55 billion and Heinz and Kraft agreed to merge in a deal worth $50 billion (source: Forbes). According to PricewaterhouseCooper’s Mid-year M&A Outlook for 2015 report, 4,654 deals worth $875 billion occurred in the first five months of 2015. This year is on track to be the largest deal making year since the financial crisis.

Since investors typically want to see revenue and earnings growth, mergers and acquisitions are expected to continue as larger companies will look for growth in this manner. So far, investors have generally rewarded the deals and it has turned into a source of momentum for the stock market.

Coming Up: A variety of home sales reports are due this week and are expected to show continued sales growth.

The views and opinions contained herein are those of Bellatore Financial, Inc. and have been researched and analyzed by Jonathan Scheid, CFA, President & Chief Investment Officer.

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