What Is Pure Play?
Pure play refers to a publicly traded company that is focused on only one industry or product. Pure play companies are popular with certain types of active investors who want to make specific bets on particular products or industry segments. For these investors, buying a company with several diversified business lines forces them to take unnecessary risks in industries in which they do not want to invest.
Understanding Pure Play
Investors, particularly analysts, like pure plays because the cash flows are easy to follow. While pure play companies are rare, they provide analysts with greater accuracy for the development of valuations based on relative and precedent transactions. An example of a pure play is Starbucks Corporation (NASDAQ: SBUX) because the business is focused on selling coffee. An example of a company that is not a pure play is General Electric (NYSE: GE), which has many different business lines and brands.
Pure Play Usage
For analysts, pure plays represent an opportunity to obtain more accurate data for a comparable company analysis or peer analysis. These reports are a vital source of information for investment analysis and the basis for relative valuations. Relative values include price-to-book ratio, price-to-earnings ratio, price-to-sales ratio and price-to-cash flow. Each of these values can help the investment analyst calculate the relative value of a company and to evaluate whether the company is overvalued or undervalued. These relative values are based on a peer group. Failure to select the right peer group can lead to inaccurate valuations and the loss of money. With a pure play, the more focused a particular company is, the easier it is to provide a valuation because the cash flows belong to one business. A company with two lines of business may have different profit margins.
Example of a Pure Play Analysis
An analyst has been tasked with valuing Company A. The analyst needs a peer group of pure plays to develop the best analysis. Company A manufactures zippers. The analyst finds five other companies that manufacture zippers to conduct a comparable company analysis. However, only two of the companies are pure plays. That is, only two of the companies manufacture only zippers. The other three companies manufacture zippers and have a stake in local mining operations. Mining operations are a very different business model. The three companies with business operations in both zippers and mining are not considered pure plays, and they are not included in the peer group because they skew the analysis. Pure plays are also used to obtain the peer group for beta or risk analysis.