Industry Concentration

Concentration refers to the number of major competitors in a given industry. The best industries, from an investing perspective, are near monopolies, that is, highly concentrated industries. Leading firms in concentrated industries, those with only two or three major competitors, typically report higher profit margins than companies in fragmented markets. These firms give a higher priority to increasing profit margins than to gaining market share through pricecutting. Oil refiners and automobile makers are examples of concentrated industries.

Conversely, fragmented markets with many participants vying for position are usually price competitive, resulting in lower profit margins. For instance, the apparel industry with dozens of companies battling for market share generates net profit margins around 6 percent, compared to the 11 percent average margin for all companies making up the S&P 500 Index.

New, high-growth industries start out fragmented, and then concentrate over time as the winners emerge. Therefore, whether a fragmented market is a good thing or a bad thing depends in the industry’s maturity and growth rate..

Growth investors usually do well picking the strongest player in a concentrated, high growth industry. Microsoft and Intel during the early- to mid-1990s are prime examples. However, picking the eventual winner in a still-fragmented emerging industry can be even more profitable because the biggest stock market profits typically accrue to the winners.

Here are some examples

Intel’s $232 billion market capitalization not only dwarfs number two Texas Instruments’ $58 billion, but exceeds the combined value of all general-purpose chip makers.

Wal-Mart’s $252 billion market-cap similarly overwhelms second banana Target’s $36 billion, and Costco places a distant third at $20 billion. Wal-Mart’s market capitalization exceeds the combined value of all other discount variety stores.

In the software industry, Microsoft’s $367 billion towers over number two Oracle’s $85 billion.

Citigroup’s $252 billion similarly overwhelms number two banker Bank of America’s $98 billion market-cap.