What Is a Pure Play?
A pure play is a company that focuses solely on one type of product or service. Investors often favor pure play companies because they are easier to analyze and provide maximum exposure to a specific market segment.
A pure play can be contrasted with multi-divisional corporations or conglomerates, which offer numerous products and services across various industries.
For example, an investor seeking exposure to U.S. banking stocks might prefer purchasing shares of a company like Bank of America (BAC) over Berkshire Hathaway (BRK.B) because Berkshire Hathaway’s involvement extends beyond banking into multiple industries and sectors.
Inspirational Takeaways
- A pure play refers to an investment in a company focused on one specific industry or niche.
- Some investors like pure plays for their ease of analysis and the dedicated exposure they offer to particular sectors.
- Identifying pure plays can be challenging as many corporations today are involved in several product lines or market segments.
Benefits of Pure Plays for Investment Analysis
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 introduces unnecessary risks in industries they prefer to avoid.
For analysts, pure plays represent opportunities to acquire more accurate data for comparable company analysis or peer analysis. These reports provide essential information for investment analysis and form the basis for relative valuations.
Relative valuations utilize metrics like the price-to-book (P/B) ratio, the price-to-earnings (P/E) ratio, the price-to-sales (P/S) ratio, and the price-to-cash flow (P/CF) ratio. These metrics help investment analysts determine a company’s relative value and whether it’s overvalued or undervalued. Pure play companies serve as excellent inputs for these analyses because they are more directly comparable. In contrast, conglomerates can’t be easily compared because their results span multiple industry sectors.
However, the term pure play is often used as an approximation since modern corporations usually have some cross-industry exposure, especially large, publicly traded companies.
Real-World Example of a Pure Play
A trader is conducting an analysis of the U.S. banking sector and aims to evaluate the relative attractiveness of various U.S. banking stocks based on PB and PE ratios. Here’s the list compiled for analysis:
- BB&T Corporation: PB of 1.28 and PE of 12.98
- KeyCorp: PB of 1.06 and PE of 10.58
- SunTrust Banks: PB of 1.16 and PE of 11.88
- Citizens Financial Group: PB of 0.75 and PE of 9.59
While every business is complex and unique, this analysis shows that these four banking stocks are relatively comparable to one another due to regional banking being integral to their business models. Therefore, they may be considered "pure plays" for the banking sector.
The trader initially contemplated including Berkshire Hathaway in the list due to its notable presence in the financial sector. However, this idea was rejected because of Berkshire’s diverse non-banking activities, which make direct comparison difficult with the pure play banking stocks.
Due to their reliance on a single sector of the economy, product, or investing strategy, pure plays often face higher specific risk. Diversification can help mitigate this risk.
Related Terms: conglomerate, market segment, active investing, peer analysis.
