Economic behavior is always an amalgam of many forces, sometimes complementary, sometimes neutralizing one other. Within the complexity, however, there are (thank goodness) usually relatively simple major themes that help to guide investment decisions, even though there may be all sorts of exceptions and qualifiers.
One of these major patterns is what happens to market shares within an industry at a time like the present, when growth will likely be shifting into a lower gear. This is my over-simple account–
the “stuff” industry
Let’s say the industry that makes “stuff” has three competitors. There”s:
Super-Duper Stuff–highest quality, great customer service
Pretty Good Stuff–acceptable quality, ok service, pricing at or maybe a tad below SDS
Awful Stuff–poor quality, poor service, but cheap.
early in the business cycle
At the beginning of the business cycle, demand for stuff explodes upward as customers who have postponed purchases during the prior downturn rush to buy.
Everyone would prefer to deal with SDS. But SDS doesn’t have the capacity to fill all the orders that come pouring in. So it puts all (or most) of its customers on allocation, giving them, say, 50% of what they request. Customers turn to PGS to fill the gap.
PGS is in the same situation. It’s swamped as well. It, too, may have to put customers on allocation.
Some customers will just wait in line and hope they get their stuff from SDS or PGS eventually. But the customers’ clients are clamoring. So, feeling pressure and afraid to lose business, others will hold their noses and turn to AS.
The overall result: SDS’s revenues will go up by, say, 20%; PGS’s will rise by 40%; and AS–which had very little business to begin with–will double, maybe triple, its sales.
later on–where we are now
Pent up demand has already been satisfied, so order growth is slowing.
People are more willing to wait. They’re choosier about what they’ll buy.
All the industry participants have added production capacity.
(And in the case of the US today, people are anticipating having less to spend on stuff in the future. So they may even be planning to cut back on stuff.)
what happens
PGS may keep some of the customers who have tried it out solely because they couldn’t get a product from SDS. Even though it is Pretty Good, however, most will shift back to their preferred supplier as soon as they’re convinced their orders can be filled.
Similarly, buyers who have patronized AS will shift either to PGS or to SDS. AS, too, may be able to keep some customers, but only if it can quickly improve its product quality and service to acceptable levels. Otherwise, virtually all the extra business it has gained will evaporate.
stock market implications
Early in the business cycle, the worst-managed, worst-positioned companies often show the strongest earnings gains. These come as a pleasant surprise–even a shock. So most times, the ASs of the world are also the best stocks–and the highest quality companies are the worst performers.
Later in the cycle, overall profit gain potential is smaller. But the highest quality firms get the lion’s share of what growth there is. The weaker companies can easily show earnings declines. If the market has come to believe that AS-like leopards have changed their spots when they haven’t, negative earnings surprises can produce ugly price declines.
Right now, I think that for companies focused on the US economy, focusing on the highest quality names has to be a high portfolio priority. You have to have truly compelling reasons–not just hunches or inertia–to remain in second- or third-tier companies.