Should you invest in market leaders?

Such companies promise stable returns even when the overall industry sentiment and growth are low. However, these can deliver lower returns than their smaller peers when the market recovers.     Most companies are finding it tough to operate in the current business environment and management teams have a single point agenda—to safely navigate the downturn and keep the business afloat. Investors are also at a loss to identify the right investments, their focus being stability rather than growth. This is leading them to a select set of companies, the market leaders that can weather the storm because of their dominant positions in their respective industries. These companies enjoy the highest profitability or generate the maximum revenue among their peers, which is why investors consider them safer bets than their smaller rivals.      While most industry leaders are established names with proven track records, should you rely on them blindly? Can these companies prove to be rewarding investments too? Let's consider if industry leaders are good investments based on their number one positions.  Benefits of leading the pack  A company becomes a leader after decades of persistence and usually boasts a sturdy and profitable business model, a sustainable competitive advantage, and a highly efficient and innovative management team. It enjoys distinct advantages that sets it apart from its rivals. These include: Pricing power: The companies  in leadership positions can effectively control the pricing in their      segments due to their strong hold over the market. Most of these are able to charge customers higher prices for their products. At the same time, they can bargain for better prices from their suppliers. Brand equity: Business behemoths boast an enormous brand power, having earned the trust of customers over several years. This becomes a high entry barrier for potential newcomers. For instance, Johnson & Johnson has become synonymous with baby care so much so that customers hardly consider any other brand in this segment. High cash flow: Industry leaders usually enjoy a healthy cash flow due to sustained high demand for their products. They tend to have deeper pockets, which allows them to spend much more on marketing efforts and acquisitions to further growth. Low cost of funds: The companies that dominate their industry usually manage to get funds at a much lower cost than their competitors. Given the high visibility of cash flow and sustainability of business, banks are willing to lend money to these companies at lower rates due to the lower perceived risk.      For investors, these companies have typical traits that make them worthy investment candidates. These stocks tend to exhibit a higher degree of certainty and stability of returns, showing lower volatility in price movement. They are among the first ones to benefit in a recovering market. They also enjoy high liquidity on the bourses as investors always have a high appetite for these stocks.  What to watch out for  When you invest in a market leader, you are placing a long-term bet that the company will continue to flourish for years and sustain its dominance. However, maintaining a big market share for a long period is a difficult proposition. Dipen Shah, head of research, Kotak Securities, says, "As the company matures, it finds it difficult to grow at the same pace, whereas the smaller players have more room to expand."      IBM is a classic example of an erstwhile industry leader turning into one of the pack. A couple of decades ago, it reigned supreme in the personal computer market, where there were high entry barriers. However, with the advent of a common operating system created by Microsoft, computers soon became commodities, and firms like HP and Dell flooded the market. IBM eventually relinquished its leadership position and had to settle for a much smaller market share.  How toppers may tumble  A company may lose its dominant position due to various reasons. Ignoring smaller firms: Sometimes, the leader may become complacent, which enables the competition to make inroads into the market and establish a small, yet firm, foothold in the industry. Once the new entrant is established, it becomes difficult to fend off the competition. For instance, Hindustan Unilever failed to respond to Nirma's entry into the low-cost detergent space in time. By the time HUL launched its own product, Wheel, to counter the threat, Nirma had already clocked 200 crore in sales.      The existing competitors are always trying to make further inroads into the  industry. To stay ahead, market leaders have to evolve with the changing dynamics of the industry. If they stagnate, they discover that their market share gets eroded and growth becomes muted. The company's stock price then starts to reflect this shift in balance. Ajay Parmar, co-head, investment banking at Emkay Global Financial Services, says, "Competitors will keep vying for a larger share of the pie, which usually belongs to the leader. So the industry captain needs to constantly be on its toes." Until a few years ago, handset maker Nokia was the undisputed king in the global mobile phone market. However, the Finnish company has now lost ground to rival Samsung, which is known to bring newer models in the market with increasing regularity.  Opting for unrelated diversification:  Since an industry leader has already captured a chunk of the market, further growth in the business is usually muted. This sometimes forces the company to venture into other businesses. If the company management is inefficient, such diversification could actually weigh down its core operations.      ITC is a rare example of a market leader (cigarettes), which has diversified successfully into other businesses(FMCG, hotels and agri-business). A market leader, in its bid to keep growth at a high level, could also be tempted to try different things, such as launching new products and making costly acquisitions, which may result in its losing the focus. Reliance Industries is an example of this attempt at diversification.  How to invest in a market leader  The stock prices of the market leaders reflect the premium position they enjoy and, hence, are typically expensive. This is why you should be cautious while buying these stocks and make sure that the company you invest in can sustain its dominance for a few more years. The topper should boast strong, sustainable, competitive advantages that can keep its competitors at bay. If you see the market leader losing its grip, check to see if the management is taking immediate steps to rectify the situation. If no such measures are being  taken, you should pull out before the stock price starts to reflect the slide. Only some companies can make it back to leadership positions, with most finding the climb back difficult.      For now, experts concur that most market leaders will exhibit strength for some more time. Saibal Ghosh, CIO, Aegon Religare Life Insurance, says that the uncertain environment has caused many of these stocks to rally, but this may not last long. "Whenever the market recovers, these stocks will witness an initial jump, but they will eventually lag behind their smaller peers." Parmar agrees, "Investors will have to be cautious as many of these stocks are trading at high valuations. Once the market sentiment improves, there will be a shift to companies that can clock higher growth."      Based on current valuations, none of the stocks carry enough upside potential to be good investment. However, those who are already invested in them can continue to hold on to their positions in select counters, such as Asian Paints, Titan Industries, L&T and ITC.