Having just finished reading another broker note extoling the fabulous growth opportunity awaiting a2 Milk Company Ltd (Australia) (ASX: A2M) it’s worth reminding investors about the limitations of relying on brokers to form your investment opinion…
But firstly, a quick recap on recent goings-on
The share prices of a2 Milk Company Ltd (Australia) and Bellamy’s Australia Ltd (ASX: BAL) have enjoyed spectacular gains in the past year. Since listing on the ASX in April 2015, a2’s shares have rallied over 190%. Meanwhile, in the past 12 months Bellamy’s stock price has jumped a phenomenal 690%!
The share price gains have been in response to both companies finding themselves in a “sweet spot”. Both companies produce baby formula and it appears that Chinese consumers have started buying these products in unprecedented numbers.
This has led to upgrades from both companies and it’s also led to brokers and analysts getting more excited about the prospects for Australian baby formula with the abandonment of China’s one-child policy just adding to the bull case for the future demand by Chinese consumers for baby formula.
Back to reality
For investors who choose not to get swept up in the hype of “demand-driven” analysis, they will remember that a market place doesn’t just depend on demand but equally it depends on supply.
The open capitalist economic framework is exceptionally well adapted to limiting the potential for companies to earn excessive profits. This is because wherever profits are high, and barriers to entry are low, competitors will never be too far away.
Indeed, investors need look no further than the recent announcement by Blackmores Limited (ASX: BKL) that it too will begin selling baby formula, to see market economics at work.
So, although the near term situation may see demand continue to outstrip supply and provide a backdrop of fast growth rates and excess profits, investors shouldn’t be at all surprised if in the medium term competition erodes much of the current market dynamics.
Indeed, investors need look no further than the recent history of BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) to realise the effect an increase in supply can have on profitability.
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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.