When you're looking at investing your money in the stocks of different companies, what do you look for? Perhaps you're looking for businesses that provide you with a steady stream of income from dividends. Or maybe you want to put your money into companies that can withstand economic pressures. Along with these considerations, you may want to look at other types of stocks—of companies that have diversified businesses and those that produce a single product line or business. The latter are called pure plays. Here, we take a look at these companies, along some of the benefits that come with investing in them, as well as the biggest risks they face.
- A pure play is a company that focuses on only one line of business.
- These are different than diversified companies which have diverse product lines and sources of revenue.
- Pure plays have easy-to-understand cash flows and revenues, and tend to cater to a niche market.
- Pure plays tend to do poorly in bear markets and come with a higher degree of risk.
What Is a Pure Play?
A pure play is an investors' term for a publicly-traded company that focuses its efforts and resources on only one line of business. As such, the performance of its stock correlates highly to the performance of its particular industry or sector.
Many electronic retailers, e-commerce companies, or e-tailers are pure plays. All they do is sell one particular type of product over the internet. Therefore, if interest in that product—or in buying it digitally—declines even slightly, these companies are affected negatively.
Pure plays tend to be e-commerce companies, but can also be large corporations like Starbucks.
Pure plays can be large corporations, too. For example, Dunkin' Brands Group (DNKN), which owns the Dunkin' Donuts coffee shops, and Starbucks (SBUX) represent pretty pure plays in coffee. An investor or trader who wants to get in on rising prices of this caffeinated commodity would likely target them. In contrast, The J.M. Smucker Company (SJM) would not be a pure play, because—even though it owns major java brands like Folger's—it also owns, and perhaps is primarily associated with, jellies, jams, and other food stuffs. It's more of a food play than a coffee play.
Pure Plays vs. Diverse Companies
Pure plays are much different than stocks of diversified companies. These are businesses that have diverse product lines and diverse sources of revenue. They may also operate in a diverse set of industries. Because they tend to offer a wider range of products and services, and may cross over two or more industries, companies that fit this profile may serve a wider, more diverse consumer base. This may help bring in more revenue, boosting their bottom lines.
Tyco International is a large conglomerate involved in a variety of industries, from home security to plastics and adhesives. Because of this diversity within its product line, Tyco's stock performance, unlike that of a pure play, is not affected by one or two concentrated factors, but by many different variables.
Why Invest in Pure Plays
Diversification has been front and center on everyone's minds for quite some time. After all, experts say you shouldn't put all your eggs in one basket by investing in a single company and/or industry. So why would anyone want to put their money into the stock of a company that only has one line of business? Well, there are actually a few reasons why investing in pure plays may be a good idea.
The first reason is because pure play companies are much easier to analysis. Because they are only involved in one type of business or product line, their revenues and cash flows are much easier to follow and understand—they're just not that complicated. This, in turn, makes their business models very predictable. It's a big contrast to diversified companies. As mentioned above, these businesses have money coming in from different sources, a wider range of customers, and cater to different industries.
Here's another reason why pure plays are attractive investments. These companies serve a niche market, so when they do well and they become popular, their revenues increase. This plays out in the financial rewards for investors—their stock prices, or an increase in dividends if they pay them out.
Pure Plays: Performance and Risk
Along with conditions affecting business, the performance of a pure play may also be highly affected by the type of investing style that targets it. For example, if a pure play's line of business is favored by growth investors, the company will do well during a bull market, when growth stocks tend to outperform the market. Conversely, during bear markets, when a value investing strategy is historically more profitable, a pure play associated with growth investing will do poorly.
Due to their dependence on one sector of the economy, one product or one investing strategy, pure plays are often accompanied by higher risk. They represent the opposite of diversified. On the other hand, this higher risk brings the potential for higher rewards because, when conditions are in their favor, pure play stocks can flourish—their performance undiluted by any other business activities.