One of the basic principles of economics is that no one makes abnormal gains (or loss) from an economic activity over a longer period. The forces of demand and supply tend to attain a state of equilibrium as higher margins attract more supplies and lower margins push the marginal suppliers out of the market. In the short term, however, suppliers can make super profits taking advantage of the demand-supply inequilibrium. Most economic activities thus follow a cyclical path rather than a linear path.
This principle does not apply to the states where markets are not free and monopolies with state protection and patronage are allowed to thrive at the expense of consumers.
We have also witnessed that businesses that own niche intellectual property rights (IPRs) or ownership of scarce natural resources have defied this principle for a much longer period of time, as compared to the usual businesses.
Applying this principle to the current market scenario, I find that the investors may be ignoring this elementary principle in their growth and profitability assumptions for the basic engineering businesses like Solar & Wind equipment & EPC, Railway equipment & EPC, Defense electronic & war equipment, and low margin electronic manufacturing, etc. Most global solar panel manufacturers are already struggling with oversupply issues.
Most analysts are projecting a linear growth for these businesses over the next several years. They are valuing these businesses on the basis of multiples of order book and sales.
I have not read any research report that says, “the fabled electronic manufacturing services (EMS) business is akin to garment export business. Its low margin assembly business which would require consistent capex and government support. These businesses will face stress every 3 to 5 years when their contracts come up for renewal. All of them carry the risk of the OEM going out of business which might take them along into a deep pit.”
Recently, ISRO chairman S Somanath “highlighted the challenges faced by the satellite launch market, stating that rockets are available but there is a lack of demand. The market is depressed, and even companies like Arianespace struggle with profitability without government subsidies. The main issue is that there are a limited number of players in the satellite market, leading to fierce competition. To address this, there is a need to create internal demand and a robust ecosystem, as waiting for foreign satellites is not a sustainable approach”. (Economic Times, 17 June 2024)
There is a rush to buy the defense tech indigenization and export theme. Demand for the stocks of potential drone manufacturers far exceeds the supply, resulting in an exponential rise in stock prices. Investors are not recognizing that in countries like the US and China, high school students are learning how to design and manufacture drones. Artificial intelligence (AI) may make conventional weapons redundant in no time. The future wars may be fought in cyber space rather than the battlefields with guns and missiles. The ongoing Russia-Ukraine war is a classic example of the complete failure of conventional weapons and war strategies.
The following meme regarding popularity of Electric Vehicles most aptly sums up the fallacy of these popular investment themes. (Sourced from social media, copyrights fully acknowledged)
Investors accepting the promise of 100% EV vehicles in two decades must assess the scenario where the copper price exceeds the gold price!!!
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