NEW YORK ( TheStreet) -- Plenty of fund managers like to own top dogs, stocks that have the biggest market values in their sectors.
But some portfolio managers are wary of buying the No. 1 stocks. Instead, they tend to prefer stocks that rank second or lower. "In general, the No. 2 stocks tend to be cheaper, and they can be more dynamic," says Tom Forester, portfolio manager of Forester Value (FVILX). "The No. 2 managements can be a little more aggressive because they are trying to get the lead. The No. 1 companies may be more cautious because they are trying to protect their leads."
No. 1 companies usually deliver poor returns, according to a study by Rob Arnott, chairman of Research Affiliates and portfolio manager of PIMCO All Asset (PASAX). During the first year after they became top dogs, 59% of the companies underperformed their sectors, Arnott found. Over the next decade, two-thirds lagged their sectors. On average, top dogs trailed by more than 3 percentage points over 10 years.Arnott says that companies move to the top of the heap by having superior products and shrewd managements. Investors bid up the stocks, figuring that the strong performance will continue. But all too often, the shares become overpriced, which hurts future returns. Once they gain the top positions, companies have trouble remaining dominant because smaller competitors develop innovative products and steal market share. In addition, regulators often take aim at the top dogs. As a result, No. 1 companies regularly lose their leading positions. In the 1980s, the government dismantled top dog AT&T (T), arguing that it was too powerful. A decade ago, Washington attacked Microsoft (MSFT), claiming it was a monopoly. That slowed the company's growth at a time when small competitors were nipping away at market share. Microsoft soon lost its No. 1 position in technology. Arnott says that top dogs tend to begin slipping within a few years of gaining their No. 1 position. During the past 60 years, the average industry sector had six different top dogs. One exception has been energy. For the entire six decades, Exxon Mobil (XOM) and its predecessors have held the top position. Arnott speculates that the company has maintained an edge by focusing on its core business and avoiding expensive combat with regulators and competitors.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV