The Expanding-Market-Share Fallacy?

When it comes to recessions, particularly bad ones like that which we’re seeing now, the strong survive. Good companies persevere, and pick up market share from their weaker rivals, which can lead to big stock price gains — or so the theory goes.

But Francois Trahan, the chief investment strategist at International Strategy & Investment Group, tells Barron’s that his research finds that’s not necessarily true. ISI’s study of the top 1,000 U.S. companies divided the group into three categories: those growing market share rapidly, those maintaining or increasing market share slightly, and those losing significant market share. (It also did the same using asset growth.) Its finding: Companies with rapid market share or asset growth underperform.

The study, which goes back to 1985, found that rapid market-share gainers underperformed the average of the 1,000 stocks studied by 0.1 percentage point a year, and the rapid-asset-growers underperformed by 2.6 percentage points annually. (Firms maintaining market share, meanwhile, outperformed by 0.7 percentage points a year, while those losing market share underperformed by almost 2 percentage points a year.) “Those lower returns [from market-share gainers/asset growers] might appear small, but when the returns’ consistency over more than two decades is contrasted against an entrenched market faith in buying market-share growers, investors should take notice,” writes Barron’s Vito Racanelli.

One theory behind this data is that a lot of companies gain market share not because they have a great product or excellent business, but by other means. “Typically, companies that chase share do it by offering incentives that eat at cash flow and earnings,” Trahan said. Such firms may lower prices, or extend the amount of credit they offer or the time to pay it back, Racanelli notes.

All of this doesn’t mean you should avoid market-share-growers, Racanelli says. What it does say is that picking stocks simply because they are expanding market share isn’t wise. “I would never not own a stock because it’s a market-share gainer,” Trahan said. “You could miss an Apple or Microsoft in its prime.”

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