Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Wisdom

Why Bigger is better for Value Investors

Many observers are both confused and frightened by the drive of companies like Amazon (NASDAQ: AMZN), Tencent Holdings (HKG: 0700), Walmart (NYSE: WMT), Volkswagen (ETR: VOW3), and Alphabet (NASDAQ: GOOG) to grow as big as possible. They wonder why corporations have an ingrained drive to get big, and why giant corporations are often in dominant in the markets.

These questions can be best answered by thinking of the market as an ecosystem. In natural ecosystems, the biggest creatures usually eat the most, live the longest, have the most freedom, and have the best chance of survival. The same rule holds for the markets, the biggest corporations last the longest, make the most money, and have the most freedom.

Contrary to popular belief, evolution usually favors the big over the small. A perfect example of this is the elephant, in its natural environment such as the African Savanah the elephant is king.

How Elephants Explain the Success of Giant Corporations

Elephants can eat as much as they want because they can simply muscle any competing animal out of the food supply. Since the elephant is the biggest and strongest creature around, no other animal is going to get between her and the food.

Size allows elephants to thrive in an arid climate because they can eat all the food. Elephants can also range over a wide area, and live in a wide variety of climates. Elephant tracks have been seen high on Mount Kilimanjaro which is 19,895 feet in elevation.

Elephants dominated their environment for hundreds of thousands of years and spread all over the world. Just 10,000 years ago furry elephants called Wooly Mammoths were the dominant creatures in North America and Europe.

Elephants only lost their perch because humans got smarter and figured out to how to make better weapons. Wooly Mammoths were wiped out by our ancestors with weapons like spears.

Giant corporations are like elephants they dominate their environments completely until smaller, smarter competitors learn new tricks. The difference between corporations and elephants; is that corporations have human brains behind them. The humans running the corporation are often smart enough to adapt to changing times.

Dinosaurs were Successful

Strangely enough, dinosaurs are another great example of how evolution favors size. Paleontologists think dinosaurs ruled the Earth for around 150 million years. The dinosaurs were so successful that it took an extraordinary event; probably a gigantic asteroid smashing into the Earth, to wipe them out.

Elephants and dinosaurs can teach investors an important lesson – evolution favors the big. The largest competitors will almost always survive and thrive under most conditions.

It takes either a very extraordinary event; what our friend Nassam Taleb calls a “Black Swan,” or a competitor with extraordinary advantages to change that. Therefore, in most cases, it pays to bet on the big guy, because he usually wins the fight.

Why Size Matters for Corporations

Like giant animals, giant corporations survive and thrive even after extraordinary setbacks. A great example of this was the Standard Oil Trust, America’s largest corporation in the early 1900s.

Even though Standard Oil was broken up by Federal regulators in 1911, its components are still around in the form of such companies as Exxon-Mobil (NYSE: XOM) and Chevron (NYSE: CVX). History teaches us that Standard Oil’s owners; the Rockefeller Family, actually made more money and got richer after the company was broken up.

Stock prices indicate that investors grasp the importance of size – even if analysts and intellectuals do not. Amazon stock was trading at $1,610.15 a share on 25 May 2018 for example. People buy AMZN because it is the most prominent retailer around and the biggest player in e-commerce.

Lessons in Bigness for Investors

There are a few ways that value investors can capitalize on the importance of size.

The most obvious stratagem is to look for giant companies with undervalued stock. Great examples of this in the modern market include America’s largest standalone grocer, Kroger (NYSE: KR). Kroger operated 2,782 supermarkets, 2,268 pharmacies, and 1,489 filling stations in February 2018. Kroger reported $122.66 billion in revenues on January 30, 2018, yet its stock was trading at just $24.61 a share on 25 May 2018.

The sheer size means that Kroger is likely to stay in business and make money even if the market changes. Kroger has the resources to enter the online grocery and grocery delivery businesses in a big way.

Kroger and the British online retailer Ocado Group PLC (LON: OCDO) have plans to establish 20 robotic grocery fulfillment centers across the United States, CNBC reported. Each of those fulfillment centers may employ up to 600 people. Kroger is already offering grocery delivery in dozens of markets across the United States.

Kroger an Undervalued Giant

Joining up with Ocado can help Kroger expand in areas where it currently has no presence, Chief Financial Officer Mike Schlotman told the audience at the BMO Capital Markets Farm to Market conference. The automated warehouses, which Schlotman calls sheds can help Kroger expand its footprint, Bizjournals reported.

“We would have the expectation that these sheds will turn up in areas where we don’t have brick-and-mortar today, where the population may be more dense; and home delivery is a bigger piece of the business, and a way to get in business in parts of the country where we aren’t today,” Schlotman said. “And then perhaps figure out what brick-and-mortar you may need to supplement that.”

Kroger’s size enabled it to snap up the meal-kit company Home Chef for $700 million, Bizjournals reported. The size enabled Kroger to convert a potential foe into a possibly valuable profit center.

Other undervalued giants that investors can look into include Oracle (NYSE: ORC), Bank of America (NYSE: BAC), American Express (NYSE: AXP), Microsoft (NASDAQ: MSFT), The Ford Motor Company (NYSE: F), Target (NYSE: TGT), Exxon-Mobil (NYSE: XOM), Facebook (NASDAQ: F), and The Walt Disney Company (NYSE: DIS). All of these companies have the revenue and sheer size to dominate segments of the market with new technologies if they executive clever strategies.

Inside an Ocado fulfillment center in England.

The strategic edge points to another advantage that the giants have, they do not have to be the smartest or fastest because of their size. As in a fight, the bigger combatant’s size often makes up for superior skill, speed, or agility. A larger competitor can win with an inferior strategy; or less-advanced technology because it has the size.

Searching for Potential Giants

Beyond undervalued giants, speculative investors can look into companies that might grow into goliaths someday. Potential giants to take a look at include; PayPal (NASDAQ: PYPL), Square (NYSE: SQ), NVIDIA (NASDAQ: NVDA), Tesla Motors (NASDAQ: TSLA), and Netflix (NASDAQ: NFLX).

Investing in potential giants is not for the faint of heart, because growing big requires taking big risks. The market ecosystem is filled with the carcasses of dead companies that failed to get big. These companies often end up as food for the successful giants.

Why nobody likes Big

Investing in bigness is a great contrarian strategy because human beings have a natural prejudice against big. Most of us dislike big because we have been pushed around by the big guy or big gal at some point in our lives.

Memories of the schoolyard bully run deep in our subconscious. We all remember the wiseass jerk who gave everybody but the biggest kid in class a hard time. Genetically, humans are hardwired to fear the big. Our ancestors survived in prehistoric times because they were smart enough to hide from the elephants. More recently, many of our ancestors were oppressed and persecuted by the armies of larger powers.

Ocado robots at work.

The aversion to bigness is part of our culture; we root for the little guy, not the big bruiser. The myth of the plucky small guy triumphing over the big has always sold, examples range from David and Goliath to Star Wars.

Even our view of history is distorted by this nonsense. We celebrate the myth of the heroic resistance fighter or guerrilla and remember the brave commando while ignoring the real causes of our ancestors’ victories.

The United States, the Soviet Union, and the British Empire won World War II by building war machines that were bigger and badder than anything the Germans and Japanese had. Heroic commando raids and individual fighter pilots only win battles in movies – not on the real battlefield. America won its independence in the Revolution by enlisting a powerful ally with a large professional military France – not by shooting at the British from behind trees.

History teaches us that the ragtag guerilla movement usually gets wiped out by the giant military machine. History also teaches us that giant corporations usually win the battles in the marketplace.

Learning the importance of bigness and understanding its role in success is vital for investors. Investors that understand why “bigger is better” can put themselves in a position to make more money.