A growing competitive threat may show up in the marketplace before it fully appears on a company’s financial statements.
Diana Weng
When rivals increasingly move into a company’s product space, the shift can signal lower future profitability, more volatile results and challenges that investors and analysts may not immediately recognize, according to research coauthored by Diana Weng, assistant professor of accountancy at the University of South Florida.
The study, published in Contemporary Accounting Research, examines “product market fluidity.” The measure tracks changes in rivals’ annual 10-K product descriptions to identify when competitors increasingly overlap with a company’s existing products.
The researchers found that greater competitive fluidity was associated with lower future profitability and operating cash flows, along with greater variability in both. Companies facing stronger emerging threats could still achieve modest sales growth, but their operating, research and development, and advertising expenses tended to rise faster, putting pressure on margins. Strategic investments could partially offset those effects.
The findings also suggest the market may underestimate emerging competition. Companies with greater fluidity experienced lower future excess stock returns, while analysts tended to issue more optimistic earnings forecasts.
Authors: Marcus Kirk, University of Florida; Zhenhao (Jeffery) Piao, University of Missouri-Columbia; Diana Weng, University of South Florida.