The Danger in Buying the Biggest

There is a French saying: "Buy on the cannons, and sell on the trumpets!" Whether they were speaking metaphorically or not, that's exactly what Sir John Templeton did.

When World War II broke out in Europe in 1939, he borrowed money to buy 100 shares in each of 104 companies selling at $1 a share or less, including 34 companies that were in bankruptcy. Only four turned out to be worthless, and he turned large profits on the others after holding each for an average of four years.

Templeton is considered by many to be, perhaps, the greatest global stock-picker of the 20th century, so it seems worthwhile to subscribe to his proven theory of buying beaten down-stocks at points of maximum pessimism. The reverse of Templeton's approach would be to buy stocks at points of maximum optimism -- and a good place to find optimism is among the most valued businesses in the world.

If you started with $10,000 invested in the most valuable business when the Fortune 500 list was released in April 1987 (that year it was IBM (IBM - commentary - Cramer's Take)) and every year thereafter reinvested the funds in the new (or same) most valued business, by 2002, you would have realized an annualized gain of just 3.3%. Over the same period, the S&P 500 delivered about 10% annualized.

While the data demonstrate the superiority of the maximum pessimism investment approach, there is something interesting at work here. An examination of the table shows that none of the most valued businesses got much beyond $100 billion in revenue or $10 billion to $15 billion in net income.

In fact, other than three years, the highest net income of the most valuable business has always been under $10 billion. Why is that? Is there a natural upper limit on revenue or profitability of a business?

---

Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. At time of publication, Pabrai held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback at [e-mail]. You can access his Web site at www.pabraifunds.com.

TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.