How Dividend Growth Mitigates the Risks of Market Concentration

“Market risk is like taking a plunge into a cool pool... a lot of people are finding out right now what their risk tolerance is." – William J. Bernstein

In a world where highly concentrated markets can disproportionately influence your investment returns, understanding the associated risks is vital. 

A handful of the world's largest companies account for a startling amount of indexes by weight— a phenomenon known as market concentration. While such an arrangement might seem like a good deal for investors who happen to be holding those winning stocks, the broader implications are complex and, frankly, carry significant risks for your portfolio’s long-term health.

Although we've discussed these issues in the past, given recent events, we feel it's a good time to return to the subject using recent data and historical evidence to illustrate the point. Along the way, we'll also explain the benefits of a disciplined strategy for investing in dividend growth and how it can provide a smoother, more reliable path to financial security.

The alarming rise of market concentration

Market concentration measures the degree to which a relatively small number of large firms account for an outsized portion of the total market cap. Several factors contribute to this trend, including mergers and acquisitions, investment trends, monopolistic control over a certain product, and, most recently, a surge in big tech developments like artificial intelligence.

Looking at the S&P 500, the top 10 companies dwarf the bottom 490. As of early 2025, those ten companies represent over 35% of the S&P 500’s total weight, a substantial increase from the 19% in 2010.¹

Examples abound. In the tech sector, companies like Apple, Microsoft, Amazon, Alphabet (Google), and Meta (Facebook) control vast swaths of the digital landscape. In consumer goods, a few multinational corporations own a multitude of brands. Even in seemingly fragmented sectors, such as healthcare, consolidation is becoming increasingly prevalent.

Why market concentration is a risk

While a few dominant companies might deliver impressive returns in the short term, relying heavily on them exposes investors to several potential pitfalls:

• Increased Volatility: If a significant portion of your portfolio is tied to a few large companies, their performance heavily influences your overall returns. A single misstep, regulatory change, or industry disruption impacting one of these giants can have a disproportionately negative effect.

• Heightened Expectations: Nvidia, which experienced explosive price appreciation and earnings growth through AI-excitement, also announced their quarterly results recently—the company's revenues beat expectations, rising by 78% year-over-year, but investors were seemingly hoping for more. Although there were other factors contributing to the total decline, the week following the earnings call saw Nvidia shares fall by 14.1%.²

• Diminished Diversification: True diversification means spreading your investments across different sectors, industries, and asset classes. Relying heavily on a handful of dominant stocks inherently reduces diversification, making your portfolio more susceptible to sector-specific downturns or company-specific risks.

• Stifling Innovation & Anti-Trust Risk: While not directly impacting investment performance, market concentration can be a societal concern. Dominant companies may have less incentive to innovate given the comfort of occupying a leadership position. Under pressure to promote competitiveness, government and regulatory bodies are increasingly putting these dominant firms under scrutiny, raising the risk of anti-trust investigations and potential forced breakups, which could impact shareholder value. We saw a rise in these investigations in late 2024 and early 2025, notably in the tech and pharmaceutical sectors.

• Valuation Bubbles: Popularity can lead to overvaluation. Leading businesses, often fueled by momentum and investor enthusiasm, can trade at valuations that are unsustainable in the long run. When the market corrects, these high-performing stocks are often the first to fall, leading to significant losses for those who bought in at inflated prices. This scenario echoes concerns raised by analysts in early 2025 regarding the lofty valuations of certain AI-driven tech companies. The dot-com bubble is a historical example of how quickly market structures can go sideways.

• Hidden Dependencies: Modern supply chains and business models exhibit intricate interdependencies. A seemingly isolated event affecting one dominant player can have cascading effects on its suppliers, partners, and even competitors. This interconnectedness amplifies the risk of market concentration. If Taiwan Semiconductor, the lead supplier of chips for the Magnificent Seven, hypothetically experienced production shortages, companies reliant on its goods could struggle to get their products or services into the hands of customers.

Dividend growth investing: offsetting risk

So, how can investors mitigate the dangers of market concentration? A well-executed dividend growth investment strategy offers a compelling solution.

Dividend growth investing focuses on acquiring shares of companies with a long track record of consistently increasing their dividend payouts year after year. This serves as an indicator that they're often mature, financially stable, and proven businesses with a competitive advantage and a commitment to rewarding shareholders.

Here's how dividend growth investing helps offset the risks of market concentration:

• Focus on Quality and Stability: Dividend growth companies are typically well-established businesses with a durable edge in their field—for example, PepsiCo has brand recognition, loyal customers, and an impressive market share, fuelling 53 years of consecutive dividend increases.³ These companies are often less volatile than growth stocks reliant on future earnings potential. This focus on quality provides a buffer against market downturns and reduces the risk of significant capital losses.

• Diversification Through Dividend Payers: While market indices may be concentrated, the universe of dividend-paying stocks is far more diverse. A dividend growth portfolio can be constructed with holdings across various sectors and industries, providing enhanced diversification and reducing reliance on a handful of top-performing companies. One might hold shares in utilities, consumer staples, healthcare, and financials—sectors often underrepresented in concentration-heavy indices.⁴

Income Stream as a Buffer: Dividends provide a fairly consistent stream of income, regardless of market fluctuations. This income can be reinvested to purchase more shares, further compounding returns to accelerate growth while providing a cushion during periods of uncertainty. This additional return is especially valuable in volatile markets where capital appreciation is less reliable, often gaining traction with investors during periods of uncertainty.

• Disciplined Growth: Dividend growth investing favours a disciplined, long-term approach. It encourages investors to focus on the fundamentals of the business rather than chasing short-term trends or getting caught up in market hype. This thoughtful approach helps avoid the temptation to overinvest in potentially misvalued stocks.

• Long-term Returns: Over the past few decades, dividends have been rather important in determining the returns investors have received. Going back as far as 1960, reinvested dividends and the power of compounding—shown in the chart below—account for 85% of the cumulative total return of the S&P 500, which translates to 31% on an annual basis. The figure below shows the growth of $10,000 over course of several decades, highlighting a remarkable difference.

  
  

  

• Alignment with Shareholder Interests: Companies that prioritize dividend growth are typically managed with a strong focus on shareholder value. This alignment of interests reduces the risk of mismanagement or decisions that could negatively impact long-term returns. The continuous pressure to maintain and grow dividends acts as a powerful incentive for responsible corporate governance, as companies that reduce or cut dividends altogether often have their stock prices punished.

An active manager's differentiated approach to dividend growth

Building a successful dividend growth portfolio requires careful research and due diligence. Here are some key considerations that active managers keep in mind:

• Dividend History: Look for companies with a long and consistent history of increasing their dividends. A company with a 10-year or even 25-year track record is preferable.

• Payout Ratio: Ensure the company's payout ratio (the percentage of earnings paid out as dividends) is sustainable. A payout ratio that is too high could indicate that the company is struggling to generate sufficient cash flow to support its dividend.

• Financial Health: Analyze the company's balance sheet and income statement to assess its financial health and long-term viability.

• Industry Outlook: Consider the prospects of the company's industry and its competitive position relative to its peers.

• Diversification: Spread your investments across different sectors and industries to reduce concentration risk within your dividend growth portfolio.

Conclusion

Market concentration is a growing reality in today's investment landscape, presenting significant risks to portfolio performance and your long-term objectives.

By embracing a dividend growth investment strategy, investors can mitigate these risks, build a more diversified and resilient portfolio, and generate a consistent stream of income to help achieve their financial goals. While it won't eliminate risk entirely, it offers a viable method to endure difficult economic times or high market concentration. Remember to do your research, stay disciplined, and focus on the fundamentals of the businesses you invest in.