It seems like a no-brainer: if a company makes popular products or services and claims the lion’s share of the market, it ought to rule the stock market as well. That’s largely why your stocks-to-buy list includes telecom giant Airtel, car leader Maruti and the Goliath of the paints industry, Asian Paints. And indeed, all three are good stocks. So this is not a bad strategy, is it?
But consider this. For every market king like Airtel, there is a market leader like Jet Airways, which has been trading way below its offer price. So, using market share as a filter is not foolproof. The sales leader of an industry need not necessarily be the profit leader too, although it definitely helps. “High market share enables a company to get better terms of trade and economy of scale and it can be a price leader,” says Rajat Jain, CIO, Principal PNB AMC.
|"High market share enables a firm to get better terms of trade and economies of scale and it can be a price leader"|
—Rajat Jain, CIO, Principal PNB AMC
"The market leader is best placed to take advantage of any opportunity that may arise in its sector"
—Hitesh Agrawal, Head (Research), Angel Broking
|Click here to see the table: But are they worth buying?|
Look at the market share—and then consider other factors as well before deciding whether or not to buy. Take the case of Ballarpur Industries. It has a 50% market share in the coated wood-free paper segment and a 30 % market share in the high-end uncoated wood-free paper segment, making it the undisputed leader in the Indian paper industry. But is the company worth buying? What is its profitability?
For every Rs 100 that Ballarpur Industry earns, it spends Rs 73.98. The industry average is Rs 80.7. Clearly, we are looking at a sales and profit leader. And as the company has sustained this performance without selling its products cheap or below cost price, the profit margins seem sustainable.
“In a commodity business like paper, differentiation at the product level is relatively less. So the dominant player, which has access to an established distribution network, branding and capital to increase scale, reaps better return on investments,” says Chintan Mewar, senior analyst, Tower Capital & Securities.
Market leaders also report better profit margins as they benefit from economies of scale. Airtel, for instance, which has the highest subscriber base in the industry, has managed to withstand competition thanks to this. Economy of scale has also made it viable for the company to pre-empt competitors and cut STD charges, which further added to its subscriber base. So, although Airtel’s revenues per user are falling, its total revenues are rising. “The market leader in this case is best placed to take advantage of any opportunity that may arise in its sector,” says Hitesh Agrawal, Head (Research), Angel Broking.
Asian Paints is a company that makes a strong case for using market share as the primary filter. The company has used its large market share to consolidate its market dominance. By diversifying into decorative paints and into the markets of South-East Asia, the company has overcome problems like seasonal demand, which beset the paints industry. Market dominance has a positive influence on the company’s profitability. “Typically, the industry follows Asian Paints in pricing. By virtue of its strong brand equity, it can afford to take price hikes without worrying too much about its incremental impact on volumes,” says Gautam Duggad, research analyst, Edelweiss.
We look at some of the market leaders across categories to see if you should buy their stocks.
|PBIDT to net sales (%)||Total expenditure to total income (%)||Reported net profit to net sales (%)|
|Market leader||Market share||Industry||Company||Industry||Company||Industry||Company|
|Sterlite Technologies||STL is a market leader in India with over 60% share in optical fibre and telecom cables||11.68||12.36||88.48||87.66||5.27||5.97|
|Asian Paints||India’s largest and Asia’s third largest paint company||14.90||18.00||85.33||82.31||8.68||10.98|
|Ballarpur Industries||50% share of coated wood-free paper and 30% share of high-end uncoated wood-free paper||19.59||26.15||80.79||73.98||7.81||11.59|
|Bharat Forge||Largest manufacturer and exporter of auto parts and leading chassis component manufacturer in the world||22.88||29.17||77.90||72.31||9.42||12.45|
|Cummins India||Market leader in diesel and gas power systems||14.95||18.43||85.42||82.48||9.11||12.04|
|India Glycols||Only producer of monoethylene glycol from green route. Also, the largest producer of ethylene oxide derivatives in India||13.56||26.80||86.79||74.13||5.65||13.69|
|Nestle India||Leadership position in the infant milk foods business with a market share of over 68%||16.07||20.09||84.29||80.37||9.12||11.80|
|GlaxoSmithKline||Pharma Market leader in prescription drugs with a market share of 6.4%, ranked as most preferred company by doctors||38.59||48.73||66.55||58.52||26.31||34.23|
|Bharti Airtel||Market leader in the telecom sector||32.58||41.77||68.48||58.60||13.05||24.29|
|Maruti Suzuki||Largest passenger car manufacturer||14.27||17.45||86.18||83.36||8.31||9.64|
|See table (But are they worth buying?) to check valuation and price forecasts|
Market dominance also helps sustain profitability in sectors which rely heavily on research and development (R&D). Large companies can afford to invest large amounts in R&D. A good example is Bharat Forge, India’s largest forging company. The company, while maintaining the sales lead, used part of its gains for R&D and buying new machines. This helped it climb the value chain by offering more sophisticated products than its competitors.
It is important not to equate a lead in sales with a lead in profitability too. To attain market leadership, a company might have reduced the price of its products to such an extent that profitability drops below the industry average. Then the cost of manufacturing the product may be higher than its competitors. A good example is the country’s largest cement manufacturer by capacity, ACC. The company’s PBIDT to net sales is pegged at 33% against the industry average of 36%. On the costs front, the company spends Rs 68 against the industry average of Rs 65 to earn Rs 100.
However, there are also cases where the market leader stands to lose the most with the entry of new players, if, for instance, the market itself is not growing. With a shift in preference from audio cassettes to compact discs, a market leader in audio cassettes will find it difficult to grow. That means any new player in that segment shares the same space and revenues, making it difficult for the market leader to sustain its market share and profitability.
This is where the management comes in. Take the case of ITC, a market leader in the cigarette business. The company knows that the sustainability of its cigarette market would be difficult in the long run and is therefore using its current leadership position to diversify into other high-growth markets such as FMCG, processed foods and retail. “Sometimes, a company may not be able to meet the demand of an increased market share without huge investments in new equipment and employees, and in these cases the role of the management becomes critical,” says Agrawal.
Another factor is the nature of the industry in which the company operates. If there is a possibility of product differentiation, market leaders may not be able to retain customers. Sales could go up because of increased popularity of the product, or they may go down because of a recession in the economy. Since these factors are beyond the control of a company, sales figures alone do not give accurate information about its performance.
The bottom line: don’t invest in market leaders blindly. Check their profitability and sustainability of the profit margins. Invest only if the company comes up aces on all fronts.