23 Pages Posted: 30 Sep 2004 Last revised: 7 Jun 2021
Date Written: September 2004
Until its sales of a product materialize, a firm is a "pre-producer" in the market for that product. That firm may may be a new start-up, or it may already sell other products. Firms that do not succeed in generating sales eventually become discouraged and move on to other activities. When this fate befalls a lot of firms, as it recently did in several IT-related businesses, the industry experiences a "shakeout." In the model that I will present, during the shakeout some firms switch to flatter, safer earnings. This switch raises earnings at the time of the shakeout but lowers them in the long run, and it therefore raises earnings-price ratios. This has happened on the Nasdaq since March, 2000 when the Nasdaq shakeout began.
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