 "Investing in peer stocks")
One approach to investing involves buying into several competing businesses in the same industry. It can happen in any competitive sector. To take an example, someone may want to own Colgate, Hind Unilever, P&G and Dabur, if he fancies the fast-moving consumer goods (FMCG) sector. This pattern was seen in the information technology (IT) industry boom, when "everybody" bought multiple IT stocks. It has happened in real estate, sugar, infrastructure, etc.
There are studies of the potential effects of such cases of "horizontal shareholdings". Some researchers who have studied US stocks claim horizontal shareholdings lead to less vigorous competition. For example, US-based airlines supposedly charge tickets at premiums of 3-10 per cent as an effect of many such horizontal holdings in the sector.
Most institutions have horizontal holdings. Sector funds do it by definition and index funds also have horizontal holdings as a matter of course, since broad indices always contain competing peer companies. For example, there are many banks, automobile manufacturers, IT companies, pharmaceutical companies, etc., in the Nifty. So, an index fund tracking the Nifty will have multiple horizontal shareholdings. Other institutions are also liable to develop horizontal holdings over time. The underlying logic for claiming horizontal holdings are anti-competition is as follows: Businesses compete aggressively (and slice margins down) when fighting for market share. This strong competition arises when businesses believe income accruing from gains in market share will exceed reductions in unit income as a result of lower margins.
The most common rule of thumb is to look at the top four businesses in a sector and see how much market share they control. A sector is reckoned competitive if the share of the top four is below 40 per cent. Another method of checking concentration is to square the market shares of all players and then sum the squares. The maximum value for this index is 10,000 or 100 per cent squared for a single-firm monopoly. If a few firms control high market shares, the squared sum will be large whereas. It will be low for a fragmented industry. For example, if 100 firms each hold one per cent market share, the value is only 100. The lower the value, the more competitive the industry. Such conventional measures could be deceptive in cases of big horizontal shareholdings. An apparently competitive industry could actually be highly concentrated.
A new, controversial paper from Einer Elhauge of Harvard Law School suggests anti-trust law could be used, and if necessary modified, to reduce or eliminate horizontal shareholdings. It isn't obvious what could be done and this is unlikely to be acted upon, given the proliferation of mutual funds. But it is a provocative stance that offers food for thought. There is a tendency to generate more horizontal holdings, as stock markets become more institutionalised. As horizontal holdings become more prevalent, corporates will increasingly try and protect margins, rather than fight price wars in the hopes of winning market share. So, industries with high horizontal holdings will see this pattern of reluctant competition emerge. Investors picking stocks will have to watch out for such patterns. Horizontal holdings could be an explanation or a partial explanation in cases where there is no apparent attempt to grow market share aggressively, or a tendency for several peer players to maintain margins rather than fight price wars. This non-competitive attitude is probably less likely to occur at a firm with family control or in cases where a promoter-entrepreneur holds a big stake. It is more likely to happen at professionally managed outfits with high institutional stakes. Bear these points in mind, when comparing companies in the same sectors. If you see several peer companies with similar margins and not much shift in market share, you might want to create horizontal holdings yourself.
There are studies of the potential effects of such cases of "horizontal shareholdings". Some researchers who have studied US stocks claim horizontal shareholdings lead to less vigorous competition. For example, US-based airlines supposedly charge tickets at premiums of 3-10 per cent as an effect of many such horizontal holdings in the sector.
Most institutions have horizontal holdings. Sector funds do it by definition and index funds also have horizontal holdings as a matter of course, since broad indices always contain competing peer companies. For example, there are many banks, automobile manufacturers, IT companies, pharmaceutical companies, etc., in the Nifty. So, an index fund tracking the Nifty will have multiple horizontal shareholdings. Other institutions are also liable to develop horizontal holdings over time. The underlying logic for claiming horizontal holdings are anti-competition is as follows: Businesses compete aggressively (and slice margins down) when fighting for market share. This strong competition arises when businesses believe income accruing from gains in market share will exceed reductions in unit income as a result of lower margins.
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Given horizontal holdings, the ownership of competing businesses might substantially be the same. If the ownership is the same, a monopoly situation is reached and there is no incentive to compete. If there are substantial horizontal shareholdings, the incentive is also likely to be reduced. Managements of peer companies don't need to collude or cartelise. Their strategy is driven by feedback from major shareholders who hold positions in many. In such cases, the horizontal shareholders are happier with higher margins, since apparent gains in marketshare are actually illusory. In effect therefore, horizontal shareholdings induce anti-competitive strategies. In fact, we can also look at this from a different angle, from the point of view of "corporate concentration". Concentration is defined in terms of a high percentage of market share being controlled by a few firms.
The most common rule of thumb is to look at the top four businesses in a sector and see how much market share they control. A sector is reckoned competitive if the share of the top four is below 40 per cent. Another method of checking concentration is to square the market shares of all players and then sum the squares. The maximum value for this index is 10,000 or 100 per cent squared for a single-firm monopoly. If a few firms control high market shares, the squared sum will be large whereas. It will be low for a fragmented industry. For example, if 100 firms each hold one per cent market share, the value is only 100. The lower the value, the more competitive the industry. Such conventional measures could be deceptive in cases of big horizontal shareholdings. An apparently competitive industry could actually be highly concentrated.
A new, controversial paper from Einer Elhauge of Harvard Law School suggests anti-trust law could be used, and if necessary modified, to reduce or eliminate horizontal shareholdings. It isn't obvious what could be done and this is unlikely to be acted upon, given the proliferation of mutual funds. But it is a provocative stance that offers food for thought. There is a tendency to generate more horizontal holdings, as stock markets become more institutionalised. As horizontal holdings become more prevalent, corporates will increasingly try and protect margins, rather than fight price wars in the hopes of winning market share. So, industries with high horizontal holdings will see this pattern of reluctant competition emerge. Investors picking stocks will have to watch out for such patterns. Horizontal holdings could be an explanation or a partial explanation in cases where there is no apparent attempt to grow market share aggressively, or a tendency for several peer players to maintain margins rather than fight price wars. This non-competitive attitude is probably less likely to occur at a firm with family control or in cases where a promoter-entrepreneur holds a big stake. It is more likely to happen at professionally managed outfits with high institutional stakes. Bear these points in mind, when comparing companies in the same sectors. If you see several peer companies with similar margins and not much shift in market share, you might want to create horizontal holdings yourself.