Stock markets function due to the difference in mindset. For continuous buying and selling to take place, a set of people need to be bearish on a stock, while others need to be bullish at the same time. The difference in the thought process defines everything in the markets. There are various strategies to cater to a wide variety of people. Some people believe in buying at the right valuation, while others focus on the growth potential. Similarly, there are various kinds of listed companies. Some companies have multiple distinct businesses. On the other hand, some companies operate in a single field. The second type of companies are known as pure-play companies.
What is pure play?
A broader pure-play definition would be companies that do not operate different businesses and have a singular focus on a single sector. Most companies operate in multiple sectors and have a diversified revenue model. The overall revenue numbers include a large number of smaller revenue streams. For instance, some telecom companies also have a media vertical and a television segment. Though telecommunication services are the source of the bulk of revenues, media and television services too contribute a significant share.
Pure play companies are diametrically opposite. Rather than operating in multiple sectors, they focus on offering one product or service. The rationale behind operating in a single segment is to build a world-class product or service and become a dominant player in the sector. Many pure-play companies are market leaders. Even if not the leader, pure-play companies generally are the dominant players in the market they operate. There are several quick-service chain operators in India that are pure-play stocks as they derive their entire sales from operating fast food outlets.
Is pure play strategy good?
Diversification is a much-repeated mantra of the stock markets but investing in pure-play stocks may limit diversification. However, investing in pure-play stocks may not be as risky as it sounds. Pure play stocks have their strengths.
- Best-in-class products: Pure play companies tend to produce best-in-class products as the entire financial as well as managerial capital is invested in developing and selling a single product or service. There have been many pure-play companies that have excelled to the extent of revolutionising the entire industry.
- Easy to analyze: Investing requires a thorough analysis of the prospects of the company. Companies with multiple revenue streams operating in a wide variety of sectors are relatively difficult to analyze. An investor has to understand different markets and make an informed prediction of the company’s prospects in those markets. Analyzing pure-play stocks is relatively simpler. Pure play companies have a single product or service and hence it is easier to analyze the market and make an assessment of the company’s prospects.
- Industry correlation: Pure play stocks are heavily correlated to the broader industry. Pure play companies have only products in the market and are generally the dominant player in the industry. It results in high growth when the broader sector witnesses an uptick. For instance, if you are selling only burgers, the stock price will definitely rise when the demand for casual dining increases.
Is pure play strategy foolproof?
Investing in pure-play stocks could be beneficial, but is pure-play strategy always going to be a winning bet? Though pure-play stocks have their advantages, they do have certain limitations.
- A competitor becoming dominant: Due to a singular focus on a product or service, pure-play stocks are often at the top of the chain. However, it doesn’t guarantee dominance forever. Many pure-play companies have fallen by the wayside after a competitor took the lead. Pure play companies thrive on market dominance and when a competitor takes the lead, they witness a gradual decline.
- Industry correlation: While industry correlation can be advantageous, it can also have unintended consequences. A broader slowdown in the industry affects pure-play stocks deeply. For instance, if the demand for oil and gas falls, pure-play energy stocks will bear the brunt in the absence of a diversified revenue stream.
Pure play strategy can lead to substantial returns, but an investor should take into consideration both the advantages and disadvantages. While zeroing in on a pure-play stock, look at factors like intellectual property, commercialised products, and growth prospects.