What's up with the Markets? - The Growth Illusion
- Saurabh Ved
- Jan 17
- 4 min read
The Growth Illusion: Why Fast-Growing Sectors May Not Guarantee High Returns “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” – Benjamin Graham Investors frequently face questions about their involvement in the latest booming sector, whether it’s Electronics Manufacturing Services (EMS), Electric Vehicles (EVs), Quick Commerce (QComm), or Solar Module Manufacturing. There’s often an assumption that participating in these rapidly growing industries will automatically result in favorable outcomes.
In investing, rapid industry growth is often celebrated as a signal of opportunity and profitability. High-growth sectors capture the attention of investors, generating a fear of missing out. While these industries can deliver significant short-term gains, they often come with concealed risks that could undermine long-term profitability.
Intense Competition: The Race to the Bottom
Fast-expanding industries not only attract investors but also a swarm of competitors. The entry of new players and an influx of capital often lead to heightened competition, squeezing prices and shrinking profit margins. While this benefits consumers, it can be a disadvantage for companies and their shareholders, as growth doesn’t always equate to profits. This intense rivalry can trigger a downward spiral, turning a once-profitable industry into a fiercely competitive battleground.
Sustainable returns in high-growth sectors are only possible when leading companies establish strong defenses—such as brand loyalty or economies of scale—that shield them from competitors. In nascent, fast-growing sectors, however, incumbents often lack the time to build such competitive advantages. Market leaders or early movers can struggle to maintain their dominance as new entrants disrupt existing models, leading to significant cash burn as companies vie for market share.
For example, the Quick Commerce (QComm) sector has recently gained investor interest due to its rapid growth potential. A few years ago, QComm was considered unviable, with multiple global ventures collapsing after losing billions of dollars. However, Blinkit (Zomato’s QComm arm) demonstrated a swift improvement in both growth and profitability, changing the perception of the industry. This success attracted deep pocketed players like Big Basket, Flipkart, and Amazon, as well as existing players like Zepto and Swiggy, who raised significant funds to expand aggressively. As a result, Blinkit now faces a competitive war that threatens both its profits and market leadership. Ironically, Blinkit’s early success has created a tougher environment, as the company might have fared better in a less crowded space, allowing it to build a stronger competitive edge.
A similar story played out in India’s e-commerce industry between 2010 and 2020. Companies like Flipkart, Amazon, Snapdeal, and others burned through massive amounts of capital to acquire customers. Many players went bankrupt, while survivors like Flipkart and Amazon are yet to achieve profitability.
Challenges in Picking the Long-Term Winners
While heightened competition creates challenges in the medium term, some industries may still produce long-term winners. These winners are determined by a mix of factors, including timing and amount of capital raised, the ability to develop competitive advantages, and regulatory environments. However, in rapidly changing sectors with limited history, it’s often difficult for investors to predict which companies will come out on top.
Consider India’s online food delivery market, which gained traction in 2014 with players like Food Panda, TinyOwl, and Swiggy. Zomato joined the race later in 2015 and didn’t launch its delivery network until 2017, initially considering self-delivery unfeasible. Despite being late to the game, Zomato eventually emerged as the leader, even surpassing early movers like Swiggy. Most investors betting on the sector’s growth in its early days likely wouldn’t have predicted Zomato’s eventual success.
Capital Expenditure Overload and Excess Capacity
In capital-intensive industries, rapid growth often sparks a frenzy of capital expenditure as companies rush to capitalize on perceived opportunities. These investments are usually based on the assumption that growth will continue indefinitely. However, when growth slows or demand levels off, the resulting overcapacity can lead to significant losses.
A prime example is the boom and bust of India’s power sector during the UPA government. Policies under the Electricity Act of 2003 spurred private investment in power generation. Many developers, driven by optimism, built power plants without securing adequate fuel supplies or power purchase agreements. This led to overcapacity, unsustainable tariffs, and financial strain on state-run electricity boards. Developers faced heavy losses, with some going bankrupt and others seeing their stock values plunge by over 90%.
A similar situation could arise in sectors like EMS, Solar module manufacturing or EV production, where government incentives have fueled rapid growth. While some companies are enjoying high profits today, an oversupply and reduced policy support could erode profitability in the future.
Overvaluation and Speculative Bubbles
One of the most common pitfalls of high industry growth is overvaluation. Investor enthusiasm can push valuations to unsustainable levels, driven by speculative optimism rather than fundamental value. This can lead to bubbles, where prices far exceed the actual worth of businesses. When growth slows or falls short of expectations, the resulting losses can be severe.
The dot-com bubble is a classic example. While the internet revolutionized industries, excessive speculation drove valuations to absurd levels. When the bubble burst, trillions of dollars in market value were wiped out, affecting even fundamentally strong companies.
Currently, similar speculative bubbles are forming in sectors like solar energy, defense, and quick commerce. Valuations as high as 100–150x earnings are becoming commonplace. While these industries are lauded for their growth potential, many company promoters are capitalizing on inflated valuations by offloading their stakes through IPOs or secondary sales.
Although high industry growth may seem like an ideal scenario for long-term investing, it often carries risks that outweigh the benefits. Investors can navigate the complexities of such sectors by focusing on companies with strong competitive moats, maintaining valuation discipline, and adopting a realistic perspective on growth trajectories. History has shown that patience, prudence, and a focus on fundamentals are the hallmarks of successful long-term investing.
Do write in at saurabh@anantyacapital.com if you found the blog interesting or if any of my interests intersect with yours!