I read Richard Koch’s book on the 80/20 rule (Pareto Principle) a few years ago.The book really clicked with me. Since then I constantly look for this trend in companies I work with.
The pareto principle, sometimes called the principle of factor sparsity or the law of the vital few, states that for many events approximately 80% of the effects come from 20% of the causes. This was originally observed when Pareto studied Italy’s population and wealth leading him to discover that 80% of Italy’s land was owned by 20% of it’s population. This still applies today in American with the top 20% of Americans owning 86% of the countries wealth.
How does this apply to the S&P 500? If we look at the list of companies sorted by Market cap we can see that the top 100 companies (20% of 500) make up 71% of the S&P 500 not quote 80/20 but almost!
The law of the vital few is more pronounced in the top 5 companies where 1% of the S&P 500 make up 22.5% of the total market cap of the S&P 500. Unsurprisingly they are all technology companies.