Stocks to Avoid: Diworseifications
In One Up on Wall Street, there’s a chapter dedicated to six types of Stocks to Avoid. Today I wanted to look at what Lynch calls Diworseifications.
You bought what?
In case it isn’t obvious this is a play on words for diversification’s. These are companies whose managers find share buybacks or dividends boring. Instead of returning capital to shareholders they like to seek out businesses unrelated to their own and buy them at inflated prices. Their hope is that it will grow earnings. The more common result? Earnings shrinkage.
Lynch has several examples of this phenomenon. One of my favourites is Gillette.
In the late 70’s when everything digital was cool, Gillette thought it was a good idea to diversify into watches. From that came the unsuccessful Reflex. As Lynch says, “It’s the only time in my memory when a major company explained how it got out of a losing business before anybody realized it had gotten into the business in the first place.”
Besides Gillette, Lynch discusses Mobil Oil. Through an acquisition of another diversified company it became an owner of a retail business and a company called Container Corporation. They later sold it for a fraction of what they paid. As a consequence, Mobil’s share price increased by only 10% throughout the 80’s whereas its peer, Exxon, doubled.
However, diversification isn’t always bad. Berkshire-Hathaway is an incredibly successful diversified company. There are others but as a general rule, it’s best to be wary of diversification’s.
One company that I’m watching to see how its diversification plays out is NetEase. Regulations have forced it to purchase video game producers outside of China. I’ll be interested to see if this strategy works to continue what’s been a historically strong earnings performer.
In future posts I’ll continue to look at Lynch’s advice on Stocks to Avoid. Also, I’ve finally finished reading the Nick Sleep letters which if you haven’t read are rich with investing wisdom. I’m writing a summary. Stay tuned.