Why Vanguard Isn’t Freaking Out About Fewer Public Companies

Amid cries that the number of public companies is shrinking, research from fund giant Vanguard Group that will be released in the coming weeks shows that the decline is coming exclusively from micro-cap stocks.

“We’ve taken a long look at the so-called drop-off or falling number of public companies, and it’s exclusively limited to micro-caps,” says James Rowley, head of active/passive portfolio research in Vanguard’s investment strategy group. “If you see the falling number of public companies, it’s almost all limited to the smallest of the smallest of the small. There are few, if any, implications for investors.”

Rowley explains that both active managers and index funds put money to work in the investable market, meaning large-cap, mid-cap, and small-cap companies. Micro-caps are not considered to be part of the investable universe. and few mutual funds focus on these stocks because they represent such a small part of the overall market. Micro-cap companies represent about 1.5 percent on average of U.S. market capitalization, according to Rowley.

Other research has found that the number of publicly listed companies in the U.S. has declined about 50 percent since the peak in 1996 and 1997. As a result, institutions and individuals have fewer opportunities to invest in public companies.

Others argue that mainstream investors, in particular, face a shrinking universe of stocks and little access to private markets to make up for that. But Rowley says it’s important that investors distinguish between the absolute number of companies and the notional size or value of those companies. Even if a large number of very small companies have left the public markets, their overall value is small. Vanguard is analyzing data going back to 1979 from the Center for Research in Security Prices, the research center of the University of Chicago’s Booth School of Business.

Rowley says the proportion of large-cap, mid-cap, and small-cap companies that make up overall market capitalization is very consistent going back to 1979. He says many analysts have made 1996, which had a record number of public companies, a de facto anchor point. However, the late 1990s markets were at a high point, with many companies eager to go public and cash in on rich valuations.

“If you look at the general trend in history, there’s an increase in the number of public companies leading up to 1996, and there’s been a decrease down from that point,” says Rowley. “But again, it’s almost exclusively the domain of micro-cap stocks.”

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In 1979, there were 2,044 public micro-cap companies. In 1997, there were 4,193, and in 2014 there 1,549. But they are a small part of the publicly traded universe. In 1979 and 1997, micro caps represented 3 percent of the market. In 2014, micro-caps represented 2 percent of the market. Micro-caps fell to 1 percent by 2016.

Rowley says there is also a myth in the market that investors are missing out on growth companies because of the decline in the absolute number of public companies.

“There is a belief that companies that go public are bigger than they actually are. Most are more akin to micro-caps. The Facebooks of the world are the exception,” he says.

Vanguard’s research shows the number of IPOs since 1980 that have gross proceeds larger than $100 million has stayed relatively consistent at a couple hundred a year. The number of IPOs with less than $100 million in gross proceeds has fallen off.

Rowley says Vanguard also analyzed changes in market structure and regulations that may make it attractive, from a company’s perspective, to stay private for longer. For one, the cost of complying with additional dislosure requirements and regulations has burdened smaller companies in particular.

“But that shouldn’t be construed as a negative to investors,” he says. “There are few if any implications to an investors’ ability to build diversified portfolios.”