Understanding Pure Play Companies
When investing in stocks, there are various factors to consider, such as dividend income, resilience against economic fluctuations, or diversification. However, another type of stock worth considering is that of companies focusing on a single product line or business, known as pure plays. In this article, we will explore these companies, their advantages, and potential risks.
- Pure play companies concentrate on a single line of business.
- They differ from diversified companies with multiple product lines and revenue sources.
- Pure plays have straightforward cash flows and revenues, usually targeting niche markets.
- They often perform poorly in bear markets and come with higher risk levels.
Defining a Pure Play
A pure play is a term used by investors for a publicly traded company that dedicates its efforts and resources to a single line of business. As a result, the stock’s performance is closely tied to the specific industry or sector’s performance.
Many electronic retailers, e-commerce businesses, or e-tailers are pure plays, selling a particular product type online. Therefore, any decline in interest for that product or digital purchasing can negatively affect these companies.
Pure plays can also include large corporations, such as Dunkin’ Brands Group (DNKN) and Starbucks (SBUX), which are predominantly focused on coffee. In contrast, the J.M. Smucker Company (SJM) is not a pure play since it owns both coffee brands like Folger’s and other food products like jellies and jams.
Pure Plays vs. Diversified Companies
Pure plays differ significantly from diversified companies, which offer diverse product lines and revenue sources and may operate in various industries. By providing a broader range of products and services and catering to multiple industries, these companies often have a more diverse consumer base, potentially increasing their revenue and improving their bottom lines.
Tyco International, for example, is a large conglomerate operating in numerous industries, from home security to plastics and adhesives. Unlike pure plays, Tyco’s stock performance is influenced by multiple factors rather than one or two concentrated variables.
Reasons to Invest in Pure Plays
Despite the importance of diversification, investing in pure play companies can still be advantageous. Firstly, pure plays are easier to analyze due to their single-business focus, making their revenues and cash flows simpler to understand and predict.
Additionally, pure plays cater to niche markets, and their popularity can lead to increased revenues, stock prices, or dividend payouts for investors.
Pure Play Performance and Risk
A pure play’s performance can be significantly impacted by the investing style associated with it. During bull markets, growth-focused pure plays often outperform the market, while during bear markets, they may perform poorly compared to value investing strategies.
Pure plays are inherently riskier due to their reliance on a single sector, product, or investment strategy, representing the opposite of diversification. However, this higher risk can lead to higher rewards, as their performance is not diluted by other business activities when conditions are favorable.