In technology, competition is brutal. Because technology companies grow very quickly and positive feedback loops only help top companies, the leaders win big in a short amount of time.
As an example of this phenomena, there were numerous search engines at the turn of the century with Yahoo, MSN, Alta Vista, Ask Jeeves, and Google. Now there is just one: Google.
In the solar sector, similar dynamics may play out. Currently First Solar (NASDAQ:FSLR) is the leading company for utility-scale solar plants while SunPower (NASDAQ:SPWR) and SolarCity (NASDAQ:SCTY) are the leaders for distributed power. In my opinion, as solar economics continue, these winners will keep on winning.
Three reasons why the sector leaders will keep on winning
By definition, sector leaders have more market share and bigger revenues than their competitors. With bigger revenues, the leaders achieve economies of scale in production and R&D that lead them to have higher operating margins than competitors. The higher operating margins allow them to grow faster and maintain stronger balance sheets. The stronger balance sheets often help them survive down cycles and return more capital to shareholders in up cycles. As an example of this, First Solar with its $1 billion in net cash survived the solar crash while weaker companies such as Suntech Power struggled.
Positive Feedback Loops
The sector leaders have positive reflexive loops behind them. Because they are the sector leaders with the most growth or strongest margins, the market naturally assigns them a higher valuation. The higher valuation allows those companies to issue shares, raising funds to help fuel growth. Both of these events allow the leading companies to grow faster, and the positive cycle continues.
Of all the sector leaders, SolarCity makes the most out of this type of opportunity. It uses secondaries such as the one on October 16 to aggressively fuel its growth.
Sector leaders often have some competitive advantage. SunPower has the most efficient and durable solar cells in the industry. This makes SunPower solar panels the perfect choice for the rooftop market where space is scarce. First Solar has been doing utility-scale power plants for a long time. It has the experience and expertise to make low-cost and high-quality utility scale power plants. SolarCity knows marketing extremely well by working with large home builders such as Toll Brothers and Pulte to sell its solar panel solution. Over time, these competitive advantages will allow the leaders to grow faster than their competitors and win bigger market share.
The bottom line
The value of being a sector leader cannot be overstated.
Sector leaders have lower cost of capital that allows them to grow faster. Assuming they are run competently, they will gain market share over time. They are much more likely to survive any industry downturns and return more capital in industry booms.
I believe as solar costs come down and demand rises, the sector leaders such as SolarCity, First Solar, and SunPower will benefit the most.
Jay Yao has no position in any stocks mentioned. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. 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.