The US stock market may be the biggest and most prestigious in the world, but more and more companies are choosing to ignore it, which has major consequences for global investors.
The number of publicly traded US companies has more than halved over the last 20 years, according to a recent Credit Suisse report, The Incredible Shrinking Universe of Stocks. The report, written by the firm's head of global financial strategies, acclaimed behavioural finance author Michael Mauboussin, notes that there are now fewer listed companies than there were in 1976, despite the fact that the US economy has tripled in size over the same period.
The Wilshire 5000 Total Market Index, established in 1974 to reflect the country’s 5,000 or so stocks, now has only 3,618 components, fewer than half 1996’s peak levels.
This is a peculiarly US phenomenon. Looking at 13 other developed markets, Mauboussin found that the number of public companies has risen by about 50 per cent since 1996. In theory, the US should have more than 9,500 listings today, the report estimates, meaning there is now a yawning listing gap of more than 5,800 companies.
Between 1976 and 2000, an average of 282 companies went public each year. Again, the peak was in 1996, when there were 706 initial public offerings (IPOs). Last year, that number had dwindled to just 105.
Today's companies are waiting a lot longer to go public. It's notable that Twitter, for example, waited until it was worth $14 billion (€13.1 billion) before going public; Snapchat owner Snap waited until it had secured a valuation of about $25 billion; Facebook was worth more than $100 billion before it finally went public in 2012.
In contrast, internet darling Netscape was valued at around $1.5 billion when it went public in 1995, just over a year after being founded. The average market capitalisation of companies going public today is almost $7 billion, more than four times larger than 1996's average valuations.
Higher visibility
So what’s going on? The Sarbanes-Oxley Act of 2002, which resulted in increased regulations and higher costs for companies going public, is likely a contributory factor deterring smaller, less profitable companies. However, the “trend toward delisting was firmly in place” years before new regulations were implemented, Mauboussin notes.
In truth, going public has always been a hassle for companies, what with having to deal with quarterly earnings releases, activist shareholders and higher visibility that can catalyse political pressures. Previously, companies had no choice: if you wanted to raise money, you had to go public.
Today, the need for capital is less pressing. Facebook, for example, generated $1.6 million in sales per employee last year, while Amazon generated $136 billion of sales using $19 billion in invested capital.
More importantly, the companies that do need extra capital can find it in private markets. Late last year, Airbnb raised $850 million in capital. Valued at some $30 billion, this private capital raising allowed employees to sell $200 million of stock. A total of 155 private US companies are valued at more than $1 billion; their combined market capitalisation is $585 billion.
Most of these so-called unicorns would have gone public 20 years ago, says Mauboussin. Now, they don’t need to bother.
There are more than 3,000 US private equity firms. They manage about $825 billion in assets, up from $80 billion in 1996. Two of the largest companies – the Carlyle Group and KKR – each have more than 720,000 employees in their portfolio companies – and that's not including Walmart. That's more than any US listed company.
Public companies are also perfectly willing to pay big bucks for private companies, as evidenced by the likes of Google and Facebook snapping up substantial targets WhatsApp, Nest and Instagram.
The continued decline in the number of listed companies means the US market, which accounts for 53 per cent of global stock market capitalisation, is changing. Industries are more concentrated.
Today’s listed companies are bigger, older firms with higher profit margins and a “greater propensity to return cash to shareholders”, whether via dividends or through share buybacks. Instead of raising money to grow, companies are using the stock market to return cash to shareholders.
‘Major consequences’
The shrinking stock market has “major consequences” for ordinary investors. First, they no longer have the same access to fast-growing companies, many of which are now confined to venture capitalists.
With companies waiting longer to go public, it’s becoming almost impossible to capture the upside of stocks compared to previous generations of investors. Mauboussin notes that Amazon was just three years old and valued at $625 million when it listed; anyone who bought at the time would have made 565 times their money.
Google went public six years after its founding at a value of $29 billion, resulting in a 20-fold share price increase. Facebook was eight when it listed and valued at $110 billion; investors have made 3.7 times their money, and it is “virtually impossible” for Facebook investors to ever earn Amazon-like returns.
Furthermore, analysts are examining fewer and older stocks; markets are increasingly dominated by institutional managers; individual investors are receding in importance – it all means markets are more efficient and informed.
Gaining an “edge” in older, well-established companies is “likely more difficult than it is in young businesses with uncertain outlooks”. This increased market efficiency may partly explain the rapid decline in direct ownership of stocks by individuals.
Instead, ordinary investors are plumping for indexed or rule-based strategies via exchange-traded funds (ETFs), which began gaining in popularity around the time the population of listed stocks started falling. The explosion in ETFs – there were 658 US ETFs last year, compared with just one in 1993 – has given investors an alternative to buying a specific stock, says Mauboussin.
Reduced regulations
What can be done to arrest the trend? Mauboussin doesn’t tackle this question, although the options appear limited.
There will likely be talk of reduced regulation, although this alone is unlikely to tempt companies that can easily tap private markets for capital. One possibility is that well-established shareholder rights and corporate governance procedures will be gradually overturned.
Indeed, this process may already be under way. Facebook and Google have both created classes of shares that weaken the power of shareholders. Snapchat parent Snap recently went further, issuing shares in in its recent IPO that carried no voting rights, an unprecedented move that alarmed corporate governance experts.
Shareholders may baulk at the suggestion that their rights might be diluted, but they might equally be displeased at the prospect of an investing universe that continues to shrink and their money being increasingly funnelled into a narrowing basket of stocks. In any case, it remains to be seen whether such a move would entice more companies into going public.
With private markets so buoyant, companies may continue to see public markets as a hassle they can do without.
