Conglomerates are companies that either partially or fully own a number of other companies. Not long ago, sprawling conglomerates were a prominent feature of the corporate landscape. Vast empires, such as General Electric and Berkshire Hathaway, were built𓄧 up over many years with interests ranging from jet engine technology to je𒐪welry.

Corporate conglomerates pride themselves on delivering a smooth stream of earnings and dividends–or cash payments–to investors over the long term. Their diverse product and service offering𝓰s are designed to avoid vola꧃tility or bumpy markets. In some cases, conglomerates have produced impressive long-term shareholder returns. 

However, conglomera꧂te investors have not alwa🎶ys fared well. Investors should be aware of both the advantages and disadvantages of investing in conglomerates.

How Conglomerates Work

Conglomerates are companies that do business in multiple industries by owning several companies. Conglomerates can be multinationals that have subsidiaries that are managed independently from other businesses. However, the management teams of the various businesses report into the parent company's senior management.

Conglomerates exist throughout the world in various industries, including food, retail, manufacturing, and media. For example, a conglomerate might start out as a manufacturer and as the business grows, acquire a financial services firm to offer customers credit cards to facilitate the purchase of its manufactured goods. If the manufacturer eventually needs software, iꦍt might buy a company in the technology or electronics industry.

A media conglomerate, for example, might initially own several newspapers, but over the years acquꦡire a radio station and a digital media company to help offset declining revenues from the newspaper division. One of the primary goals of conglomerates is to diversify their revenue stream so that they can produce earnings in any type of economic environment.

Advantages of Conglomerates

Conglomerates can offer advantages to inve🍷stors that ultimatel▨y deliver better returns on their investment.

Diversification

The case for 澳洲幸运5开奖号码历史查询:conglomerates can be summed up in one word: diversification. According to financial theory, because the business cycle affects industries in different ways, diversification results in reduced investment risk. A downturn suffered by one 澳洲幸运5开奖号码历史查询:subsidiary, for ins༺tance, can be counterbalanced by st🐭ability, or even expansion, in another venture.

澳洲幸运5开奖号码历史查询:Warren Buffet’s Berkshire Hathaway could be considered a conglomerate that has a majority stake in more than 50 companies, including real estate, banking, and plane manufacturing. Investors🅷 benefit from diversification because if Berkshire Hathaway's banking holdings perform poorly, the loss might be offset by a good year in its real es🎉tate business.

Profitable Acquisitions

A successful conglomerate can show consistent earnings growth by acquiring companies whose shares are rated lower than its own. In fact, GE and Berkshire Hathaway have both promised—and delivered—double-digit earnings growthꦐ by applying this investment growth🥀 strategy.

Access to Financing

The companies that are owned and managed by conglomerates can often access financing through the parent company, enabling them to invest in their long-term growth. Smaller companies might not get favorable terms in credit facilities from banks and the capital markets since their revenue and earnings performance might be intermittent or spotty. The parent company can step in and offer far more favorable terms–such as a lower interest rate–than what the markets might offer the💎 subsidiary on its own.

Disadvantages of Conglomerates

Although some conglomerates have delivered impressive returns over the long term, there are disadvantages to investing in them since ꦦnot all conglomerates are created equal.

Economic Risks Remain

The prominent success of conglomerates, such as General Electric (GE), is hardly proof that conglomeration is always a good idea. There are plenty of reasons to think twice about investing in these stocks, as illustrated in 2009, when GE suffered as a result of the economic downturn, proving that size does not make a company infallible. GE has continued to struggle to produce stable earnings and stands at a fraction of the size it once was as the management continues to divest businesses to pꦰay down d🍌ebt.

Spread Too Thin

Investment guru Peter Lynch uses the phrase 澳洲幸运5开奖号码历史查询:diworsification to describe companies that diversify into areas beyond their core competencies. A cong♌lomerate can often be an inefficient, jumbled affair. No matter how good the management team, its energies and resources will be split over numerous businesses, which may or may not be synergis✤tic.

Financial Reporting

For investors, conglomerates can be awfully hard to understand, and it can be a challenge to pigeonhole these companies into one category or investment theme. As a result, even managers often have a hard time explaining their investment philosophy to shareholders. Furthermore, a conglomerate's accounting can leave a lot to be desired and can obscure the performance of the conglomerate's separate divisions. Investors' inability to understand a conglomerate's philosophy, direction, goals, and performance can eventually lead to share underperformance.

While the 澳洲幸运5开奖号码历史查询:counter-cyclical argument holds, there is also the risk that management will k𝔉eep hold of businesses with poor performance, hoping to ride the cycle. Ultimately, lower-valued businesses prevent the value of higher-valued businesses from being fully realized in the share price.

Better Ways to Diversify

Conglomerates do not always offer investors an advantage in 澳洲幸运5开奖号码历史查询:diversification. If investors want to diversify risk, they can do so by themselves, by investing in a few focused companies rather than putting all of their money into a single conglomerate. Investors can do this far m෴ore cheaply and efficiently than even the most acquisitive conglomerate.

The Conglomerate Discount

A 澳洲幸运5开奖号码历史查询:conglomerate discount is when investors assign a lower value or discount to a c🐼onglomerate because divisions within the conglomerate are not performing well. The discount arises due to the sum-of-parts valuation, which applies a lower value to a conglomerate versus a company that's focused on their core offerings or competenci💎es.

In other words, the market can apply a haircut to the sum-of-parts value. Of course, some 🥀conglomerates command a premium but, in general, the market ascribes a discount, giving investors a good idea of how the market values the conglomerate as compared to the sum value of its various parts. A deep discount signals that sha𓄧reholders would benefit if the company were dismantled and its divisions left to run as separate companies and stocks.

Example of a Conglomerate Discount

Let's calculate the conglomerate discount using a fictional conglomerate called DiversiCo, which consists of two unrelated businesses: A beverage division and a biotechnology division.

DiversiCo has a $2 billion stock market valu🧜ation and $0.75 billion in total debt. Its beverage division has balance sheet assets of $1 billion, while its biotechnology division has $0.765 billion worth of assets.

As an example, assume that focused companies in the beverage industry have median market-to-book values of 2.5, while 澳洲幸运5开奖号码历史查询:pure play biotech firms have market-to-book values of 2. DiversiCo's divisions are fairly typical꧑ companies in their industries.꧅ From this information, we can calculate the conglomerate discount:

Total Market Value DiversiCo

• Equity + Debt
• $2 billion (equity) + $0.75 billion (debt)
• Market Value = $2.75 billion

Estimated Value using Sum of the Parts

• Value of Biotech Division + Value of Beverage Division
• ($0.75 billion X 2) + ($1 billion X 2.5)
• $1.5 billion + $2.5 billion
• Sum of the Parts Value = $4.0 billion

The Conglomerate Discount

• ($4.0 billion - $2.75 billion) / $4.0 billion
• = 31.25%

DiversiCo's 31.25% conglomerate discount shows a deep discount while its share price does not reflect the value of its individual divisions. Investors might push for 澳洲幸运5开奖号码历史查询:divesting its beverage and biotech divisions to create more value since the company co🌃uld be worth more if it were broken up into separate companies.

The Bottom Line

The conglomerate discount suggests it may not be wise to invest in conglomerates. However, investing in conglomerates that get broken up into individual companies through divestitures and spinoffs can provide investors with an increase in value as the conglomerate discount🌺 disa𝔉ppears.

On the other hand, some conglomerates command a valuation premium or at least a slimmer conglomerate discount. These are extremely well-run companies with excellent management teams and clear targets set for divisions. Successful conglomerates typically sell off underperforming companies and don't overpay for 澳洲幸运5开奖号码历史查询:acquisitions. Also, conglomerates with a premium associated with them tend to have💯🐓 sound financial, strategic, and operating objectives.