One of the most important and yet difficult questions investors face is how to identify and capitalize on existing market trends. One such trend is industry concentration and its impact on asset returns. In recent years, there has been an increasing focus on macro-investors, who closely monitor industry concentration when making investing decisions. While analysis of industry concentration has traditionally been the domain of long-term investors, research has shown that short-term investors can also benefit from analyzing industry concentration.
To understand the effect of industry concentration on asset returns, industry concentration must first be measured and analyzed. By definition, industry concentration refers to the percentage of sales associated with the top four firms in an industry. When industry concentration is high, the level of competition between the top firms is low and vice versa. When competition is low, the top firms are able to maintain high prices and strong profits.
In a study published in the May 2019 issue of the Financial Analysts Journal, researchers analyzed the effect of industry concentration on asset returns for a sample of 804 publicly traded stocks from the S&P 500 index over a 30-year period (1985-2015). The study found that a higher level of industry concentration was associated with significantly higher average returns for both large and small value funds.
In addition, the study found evidence of a “winner-take-all” effect in which the biggest firms in concentrated industries dramatically outperformed their smaller competitors. The researchers attributed this to the fact that the top firms in concentrated industries were able to benefit from economies of scale and the lack of competition due to high industry concentration levels.
Based on these findings, investors should consider the following actionable advice. First, investors should prioritize industries that are highly concentrated. By doing so, investors can take advantage of the “winner-take-all” effect in which the biggest firms in concentrated industries tend to outperform their smaller competitors. Second, investors should look for companies within these concentrated industries that are well managed and have high potential for growth. Finally, investors should monitor industry concentration levels closely and make decisions accordingly.
Overall, industry concentration can have a significant effect on asset returns. Investors should take this into account when making investment decisions, and prioritize industries with a high level of concentration. Additionally, investors should look for the biggest firms in concentrated industries and monitor industry concentration levels closely.
Concrete examples and helpful online resources to carry out this research:
Example of industry concentration calculation: https://www.investopedia.com/terms/i/industryconcentration.asp
Helpful online resource to understand the concept of winner-take-all effect:
https://www.investopedia.com/terms/w/winner-take-all.asp
Helpful online resource to understand the concept of economies of scale: https://www.investopedia.com/terms/e/economiesofscale.asp
Helpful online resource to identify stocks in concentrated industries:
https://www.fidelity.com/learning-center/investment-products/etfs/how-to-identify-the-right-etfs-for-your-portfolio
Helpful online resource to identify companies with high potential for growth:
https://www.investopedia.com/articles/fundamental/04/080804.asp
