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Hoping to get in early on the next Amazon before it becomes, well, the next Amazon?
Good luck. It’s not as easy as it used to be.
That’s because the number of U.S. stocks has been shrinking for 20 years. At last count, there were 3,599 in the Wilshire 5000 Total Market Index, which tracks all stocks actively traded in America. That’s down more than 50% from the 1997 peak of 7,459.
The smaller pool of stocks to invest in has been driven by a number of factors. Fewer young companies are opting to sell their shares to the public through initial public offerings, or IPOs. Mergers have also eliminated many stocks. The rise of private equity firms, which buy entire companies and run them privately with the goal of fixing them up and boosting profitability, has also taken hundreds of stocks out of circulation.
And every remaining stock is under the microscope like never before, as powerful computer algorithms, analysts and portfolio managers pick them apart. That makes it tougher for the little guy to be among the first investors in companies that could blossom into big winners.
Here’s how fewer stocks affect mom-and-pop investors.
1. Missing out on future winners. With young companies more frequently opting to get money from private investors instead of through IPOs, small investors have a harder time getting early access to upstarts that could be the disrupters of tomorrow, like online behemoth Amazon and social media giant Facebook.
“The primary disadvantage is that (small investors) are not getting an opportunity to buy stocks when they are in the biggest part of their growth phase,” bemoans Jason Trennert, chairman of Strategas Research Partners. “You have less to pick from the most exciting parts of the market. Silicon Valley is a crown jewel of the economy and the average person is not being allowed to fully participate (in those early-stage companies) directly.”
He notes that Amazon, which went public in May 1997, had a first-day market value of roughly $440 million. Amazon’s market cap is now $473.2 billion, according to S&P Dow Jones Indices. By contrast, Snap, the parent company of the popular photo app Snapchat, went public in March. At its offering price of $24 per share, it had a market value of roughly $33 billion on its first day. The takeaway: Tens of billions of newly created wealth were enjoyed by early SNAP investors — who were professionals — but excluded mom-and-pops.
“Companies are waiting longer to go public, thus accruing most of the gains to large institutional (or professional) investors,” explains Terry Sandven, chief equity strategist at U.S. Bank Wealth Management.
2. Fewer stocks, harder to gain edge. While individual investors might miss out on gains generated by private companies, both Main Street and Wall Street investors are equally hamstrung by a smaller pool of stocks to choose from. Why? It is even harder to get market-beating returns because the smaller number of shares that are trading are over-analyzed and picked over, which means fewer stocks are temporarily mispriced, says Bill Hornbarger, chief investment officer at Moneta Group.
“You have more eyes looking at fewer companies,” Hornbarger says. “That makes it harder to beat stock indexes (like the Standard & Poor’s 500). There’s too much money chasing the same opportunities.”
3. Access to up-and-comers through funds. But not all is lost. Individual investors can gain access to private companies via mutual funds. Fund tracker Morningstar says about 3.6% of the mutual funds it monitors — including well-known companies like Fidelity Investments and T. Rowe Price — held investments in private companies, according to second-quarter 2016 data.
The most widely held private company investments were Uber, cloud storage play Dropbox and lodging app Airbnb.
Funds make investments in high-potential private companies to get a piece of the business at a lower price than they might at the IPO and to generate better returns, says Katie Reichart, associate director at Morningstar .
But individual investors who own private companies through funds that own hundreds of other stocks should not expect turbocharged returns. A $10,000 investment, for example, in a single stock that doubles in value will net a $10,000 profit. But a similar-sized investment in a fund that owns 200 other stocks will net a smaller gain because the investment is spread out over more stocks.
“Private companies end up being such a small part of a fund that it can help returns but it certainly is not a guaranteed home run,” Reichart says.
One potential downside of fewer stocks is some indexes that are weighted by market value could end up being dominated by the biggest companies. That creates the risk of owning too big a chunk of too few stocks, many of which could be overvalued, adds Wade Balliet, chief investment strategist at Bank of the West.
And while Bob Waid, managing director at Wilshire Associates, says most “investors don’t have access to cool, young companies”, the Wilshire 5000 index is one major stock index that adds recently minted IPOs as soon as two weeks after a company goes public.
By contrast, indexes like the S&P 500 have a committee that vote on additions to the index, and they typically don’t add new companies to the index until the companies are more mature.