Conventional wisdom suggests that a company's market share predicts its profitability—active investment strategies often use this as a key metric—but empirical research finds that there is actually not much of a relationship between market share and profitability.

Verdad's Dan Rasmussen examined all US and Canadian public and private firms with more than $10 million in sales across Equity IQ 11 sectors and 160 industries – about 6,600 firms. To control for industry effects, he compared the operating margins of the largest firm in each industry to the industry average. Market share was calculated as the firm's revenue divided by the total revenue generated by businesses within a specific industry. The chart below shows that market share is not a consistent indicator of firm performance – the average r-squared was 0.0426 and no industry correlation was above 0.25. Defying conventional wisdom, many industries even exhibited a negative relationship between market share and profitability.

Rasmussen also found that in some industries, such as retail, firms with large market shares tend to have lower margins, perhaps reflecting the fact that lower prices tend to attract more customers.

As a robustness test, Rasmussen found that when using return on assets as a measure of profitability, the relationship with market share was even weaker—the r-squared was 0.0016.

He also found no relationship when using return on equity as a measure of profitability—the r-squared was only 0.00005.

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While the conventional wisdom is that companies leverage their market share to earn higher profits, empirical data shows that this is generally not the case. Instead, companies gain their market share through better products, better prices, better service, and other firm-specific strategies. In fact, Rasmussen found that most of the companies with the largest industry market share had profit margins below the market level, as 56% of the industry's leading public firms had margins below the industry average.

Rasmussen's findings have implications not only for investors, but also for corporations in terms of setting strategic objectives. Profitability has been shown to have explanatory power in the cross-section of stock returns and is thus included in the principal factor models; having a leading market share should not influence investment decisions.

Larry Swedroe is the author or co-author of 20 books on investing. All opinions expressed are his alone and do not reflect the opinions of Buckingham Strategic Wealth or its affiliates. This information is provided for general information purposes only and should not be construed as financial, tax or legal advice. Some information may be based on data from third parties and may become outdated or otherwise replaced without notice. Third-party information is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SESC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this information. LSR-24-643