What is Pure Play?
A difference of perspective on a stock amongst people enables continuous buying and selling. While a certain group would be bearish on a stock, another group may choose to be bullish at the same instance. Similarly, investors may choose to invest in a particular stock based on valuation, steady stream of dividend income, or by evaluating the potential of growth.
Investors may also have considerations regarding the types of stocks of companies with a single product line or diversified businesses. Companies with a single focus in terms of a singular product line of business are referred to as Pure Plays.
Pure Play
The term pure-play refers to publicly-listed companies with a sole focus of their resources and energies on a single line of business. Stock performance shows a high correlation to the performance of their industry or particular sector. Unlike companies that have diversified product portfolios and multiple sources of revenue, pure-play companies cater to a single niche market and have simpler, easier-to-understand cash flows and revenue structures. Amongst investors, it is a common perception that pure-play stocks may tend to perform poorly in bear markets and may be associated with higher degrees of risk.
Many e-commerce companies, electronic retailers, or simply e-tailers are all common examples of pure plays, as they all market their industry-specific products on the internet. In scenarios where there is a loss of market interest in their product or a decline in the notion of electronic retail, that is buying digitally, these companies stand to be negatively impacted.
Pure play companies are drastically different from companies that operate different businesses. Rather than managing operations in multiple industries or sectors, pure-play companies focus on offering a single product and service which often makes many pure-play companies market or industry leader. Even if not market leaders, pure-play companies are dominant players in their operating market.
Pure Play Strategy
For investors, looking to manage their investments in the stock market, diversification of their portfolio is a much-promised investment strategy. This is why considering investing in pure-play stocks is considered to be high risk as it may limit diversification. However, against this common notion, Pure play stocks have a multitude of strengths that investors can leverage while deciding on their choice of investment-worthy stocks.
- Quality of offering: As pure-play companies manage a single line of focus for their products or services, they tend to produce the best-in-class products backed by their complete financial capital and managerial strength being invested in product research and development. Multiple examples of pure-play companies over years have demonstrated revolutionizing their industry of focus, by the high quality of product delivery.
- Simplified analysis: Diversified companies often have multiple business lines, making it extremely complicated to analyze their revenue streams. As an investor, it is important to pay heed to different markets and make an informed decision regarding a company’s performance potential in the respective market. Analysis of pure-play stocks is relatively simpler. Through a single line of focus, the assessment of pure-play companies is simpler and easier.
- Correlation of Industry: Pure play companies show a greater correlation to their broader industry. With only a single sector focus, pure-play companies are usually dominant players in their market industry. A heavy correlation establishes high growth when the broader sector witnesses an upward trend.
Examples of Pure Play
Companies like Starbucks (SBUX) and Dunkin’ Brand Group (DNKN) are examples of pure-play companies in the coffee industry.
Pure Plays vs. Diverse Companies
Diverse companies are said to have an upper hand over pure-play companies, due to their multitude of operations across a diverse set of industries. With a wide range of offerings, companies with diverse product lines may often have a cross-over between two or more industries, thus catering to a large and diverse consumer base. This often helps these companies bring more revenue giving a boost to their bottom lines.
A large conglomerate, Tyco International caters to industries from the range of home security to plastics and adhesives. With the diverse product portfolio, the stock performance of Tyco is not merely affected by one or two concentrated factors but by several different variables.
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Frequently Asked Questions
Pure-play method is a finance term referring to an approach used for estimating the cost of equity capital for private companies. It requires finding and examining the beta coefficient of other public and single-focused companies. This is the coefficient of a pure-play publicly listed company with a single business focus, and using it to determine the beta coefficient of the private company. The method is also used to find the cost of capital for projects that are different from a company’s mainstream business.
Pure play companies are easier to study, analyze and evaluate for growth potential, as they are only focused on a single business type or product line, uncomplicating their revenue streams and cash flows. In comparison to diversified businesses, the business and strategy model for pure-play companies is also greatly predictable, making it an easier study to evaluate expected growth. With improved performance, the popularity of pure-play companies in their dedicated niche increases, greatly impacting their revenue and consequently their share prices proving to be attractive investments for their investors and shareholders.
The performance of pure-play companies is greatly impacted by the kind of investing style of the investors that target their stocks as their choice of investment. If favoured by growth investors, the pure-play company stocks are likely to perform well during a bull market, with the growth stocks tending to outperform the market.
Conversely, in bear market scenarios, with a value investing strategy having proved profitable historically, a pure-play company backed by growth investors may do poorly. Poor performance can be attributed to the single sector dependence, single focus product line, or the high-risk association with a one investing strategy focus.