April 14, 2010 - Big is big lately, as in Too Big To Fail headlines, referring to the biggest banks, ones like Citibank, Chase, and Bank of America. They can't be allowed to fail, the reasoning goes, or faith will be lost in the banking system. If that faith goes away, so do all the banks. And there goes capitalism as we know it. Without banks lending money for homes and businesses, there is no growth, only shrinkage.

There's another advantage to being big: you make more money. Look at the home building industry. They were leveraged to the utmost before the economy hit a brick wall going about 60. They made tremendous profits. The biggest builders borrowed money to buy land so they could develop it later, to build more houses. But when demand dried up, they were left sitting with much lower revenues and very high debt payments on land that kept going down in value.

So they did what we all did: they adjusted to the new reality. They sold lots of land at a loss, paid off the banks as best they could, shored up capital, and got ready for a long, dry spell. Now the largest ones that survived are in decent shape and ready to pounce when demand increases. They are beginning to look at buying land again. If demand roars back, they'll have the inventory to fill the need. The smaller builders didn't make it. They didn't have the capital base or enough business to see them through. The big ones did.

The fact that they were leveraged, heavily borrowing to have more land, hurt them enormously on the way down. Instead of being an appreciating asset, the land became a deteriorating drain, going lower in value almost daily. While the owners at first thought it was only a short problem, they furiously tried to sell property to lighten their loads as time taught them it wasn't. Along with the losses on sales, the debt payments were killing profits. But now, with demand stabilizing, revenues are covering interest payments which are much lower due to lower rates. The bigger builders are positioned to meet any level of demand.

The thread through all of these survivors is that they were big, they got government help or pared down to a size that allowed them to compete, and they're ready to ramp up at any sign of increased demand.

As an investor, especially in these economic times, you want to be on the side of big. Not that that means safe (after all GM and Chrsyler shareholders really bit it, as did Washington Mutual investors). All of them were big. But bigger companies have more capital to ride out an economic storm, have more assets to sell, have a better chance of survival (usually, unless they are completely ineptly managed). And when the economy starts to gain traction, it's the big companies that have the largest presence that will do the most business, make the most profits because they are positioned to do so. GE is a great example Or IBM. They have the capacity to meet the demand, whether it's in cars, houses, loans, computers or TV shows.

Sometimes bigger is better. Not always. But there is some comfort in having a large capital base, a large revenue stream, and a strong balance sheet. Together, they can help a company overcome periods when profits just aren't there.

- Ted Allrich