Understanding the basic characteristics of the capital markets is the key to successful investment, but achieving this is not easy. In addition, as there are different investment philosophies held by different investors, the capital markets are also seen differently. In this article, the author will share his understanding of two important characteristics of the capital market from the perspective of a long-term value investor, as well as the insights this brings to investment practice.

1. Horizontal asymmetrical distribution analysis of market cap of listed companies

In Nassim Taleb's book, The Black Swan, he created the concepts of 'average Stane' and 'extreme Stane' to describe the distribution of most things in reality. (1) 'Average Stane' represents a situation where the differences between individuals are not too big, such as in the field of physiology, where the height of each student in a class is not too different from the average height of the class; (2) 'Extreme Stane' represents a situation where the differences between individuals can be very large, such as in the field of economics, where the distribution of wealth among people can vary greatly from the richest person in the world to the average person.

In the capital market, the distribution of market capitalization of listed companies also belongs to the category of 'extreme Stane'. According to statistics from the World Federation of Exchanges (WFE) on the global market capitalization of exchanges in the second quarter of 2023, the market capitalization of global stocks is about $109 trillion, and the specific distribution is shown in the following table:

From a micro perspective, the distribution of market capitalization of companies within the exchange is also asymmetrical (see Table 2). Among nearly 5,900 listed companies (excluding over-the-counter trading) on the US stock exchange, the market capitalization of the top ten companies accounts for 22.64% of the total exchange, while on the Vietnam stock exchange, the market capitalization of the top ten companies accounts for as much as 77.21%.

Thus, the first basic characteristic of the capital market is that, whether it is viewed from a macro or micro perspective, the distribution of market capitalization of listed companies is extremely asymmetrical.

2. Vertical non-linear changes in market capitalization of listed companies

In the principle of value investing, the price (market cap) of a company is determined by its value (profitability or free cash flow), and the price fluctuates around the value. However, the change in value is by no means linear, and as a result, the price fluctuates with non-linear and abnormally violent characteristics.

Human society has experienced agricultural revolution, industrial revolution, and information technology revolution (currently at the beginning of the artificial intelligence revolution). The non-linear characteristics of the change in company value/market capitalization have become increasingly apparent. For investors, if they miss the opportunity of non-linear change in company value/market capitalization, they are likely to miss most of the company's returns. We demonstrate this feature through the following two examples:

(1) Figure 1 is a curve of the proportion of NVIDIA's market capitalization. From the curve, we can see that in the nearly 25 years of statistics, 80% of NVIDIA's market capitalization was created from 2023 to the present (June 18, 2024), accounting for about 5.88% of the total statistical period.

(2) Figure 2 is a curve of the proportion of Tesla's market capitalization. The horizontal axis represents time, and the vertical axis represents the proportion of the company's market capitalization at the corresponding time to the historical maximum market capitalization. From the curve, we can see that in its nearly 12-year statistics starting from the market cap peak on March 31, 2022, 80% of Tesla's market capitalization was created in a year and a half, accounting for about 12.5% of the total period.

Therefore, the second basic characteristic of the capital market is that the form of market capitalization changes is related to business models. From traditional enterprises to technology-based enterprises, the non-linear characteristics of market capitalization changes become increasingly apparent.

3. Insights into the distribution and changes in market capitalization

The purpose of cognition is to guide practice. The distribution and changes in market capitalization of listed companies contain important insights for our investment activities.

Both the distribution of market cap in global capital markets and in individual markets reflect the characteristics of the horizontal non-symmetric normal distribution of the investment world. For investors, actively choosing key countries, key industries and key companies is often the greatest source of returns.

There is a saying in China: "If you don't open for three years, open for three years." Roughly speaking, it takes six years to manage the first opening, which reflects the importance of timing. By reviewing the market cap changes of many technology companies, this particular characteristic is especially highlighted, providing important insights to investors. First of all, it emphasizes the importance of long-term investment and in-depth research of company fundamentals. Only focusing on short-term price fluctuations may lead to the missing of companies with long-term growth potential. Secondly, it also reminds investors to have a deep understanding of market sentiment and technical trends, so as to identify and invest in those companies with disruptive potential in the early stages of market cap growth.

Edited by Jeffrey