Last week I mentioned there are currently about 3,600 public U.S. companies down from around 7,355 back in 1997. That’s more than a 50% decline in only 20 years. While that number is certainly surprising, does it have any implications for you as an investor? I believe it certainly does. A few years ago while doing some research, I stumbled upon an article by Jason Zweig of the Wall Street Journal that centered around a study by the Booth School at the University of Chicago that attempted to explain why it was so hard for investors and fund managers to beat the indexes. The conclusion drawn was that since there are so many fewer stocks, it was harder for someone to effectively be a “stock picker” and uncover value because everyone is competing for the same few companies. While this explains why stock pickers have trouble beating indexes, it can actually bring up many more questions and possibly uncover some serious issues in the world of investing.

First, why are there so many fewer companies? The effects of mergers (two companies becoming one) and, more notably, private equity (capital raised by private sources instead of issuing public stock) have been the primary drivers of fewer public U.S. companies. Many companies go the private equity route because it is far less burdensome due to all of the regulation surrounding filing for an IPO (Initial Public Offering), and the ongoing filing requirements that public companies are required to make continually.

One way in which this trend affects investors is small companies receiving venture capital or private equity instead of “going public” is causing many of the large gains in a company’s early growth years to be realized by only the private investors and not the public as a whole. This leaves only the bigger more established companies to invest in, which may not be growing as fast as the smaller companies.

Second, and maybe most importantly is that fewer companies may affect historical performance data by making it less reliable since it is being produced by fewer companies. The truth is, we really have no idea what the ultimate effect will be, but I surmise that it won’t be a good one. Today, in the absence of pension plans, we all put money into 401(k)s and IRAs at an ever increasing rate. More money into the fewer companies means higher valuations. That means that the traditional measure of value for a stock, the P/E ratio (price/earnings) may be a far less reliable measure of stock value than it was 20-30 years ago. P/E ratios must go higher if there is more money going into fewer stocks. If that is true, then a traditional P/E ratio of say under 14 was considered cheap, maybe now equates to 20? 25? 30? We have to correct for the change in fewer companies and so far we have not done that.

If we don’t encourage more companies to go public, then this trend will continue. What could be the possible outcome of the trend continuing?

1. Assumptions for returns in the future should almost certainly be revised down.

2. Future market crashes could be more severe.

3. Past performance is less reliable than ever.

None of these outlooks are particularly appealing to me. While I don’t want to sound any alarms, I do think it warrants far more discussion.

T. Eric Reich, CIMA, CFP, CLU, ChFC is president and founder of Reich Asset Management and can be reached at 609-486-5073 or eric@reichassetmanagement.com.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

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