The capital cycle, as defined by Marathon Asset Management, goes something like this:
Capital is attracted to high-return businesses.
The managers of these high-return businesses become drunk on growth, and expand production in response to their great success. This is rational! It makes sense to pursue growth when there are ravenous customers and large profits for the taking.
There is a lag between this planned expansion and the actual supply in the market. It takes time to build factories, or to spin up new products. Nobody notices that future supply — across multiple competitors that are all expanding production — will soon outstrip demand.
The new supply gradually floods the market, and returns fall below the cost of capital. Businesses slash prices to offload supply; company valuations collapse.
Capital flees the sector because returns suck; companies close down or get bought out; consolidation occurs across the entire industry.
This sets the surviving companies up for future excess returns.
The capital cycle is amongst the most basic patterns that you will find in finance, and one of its simpler ideas — perhaps second only in simplicity to the credit cycle. But of course the question that’s worth asking is: how do you exploit it?
This concept sequence captures cases of businesses navigating the capital cycle — either surviving it, successfully exploiting it, or dying in the grips of it.