Stock Market Tips 6

Does the company have a core competence or is it diversified?

Diversification in a company can take many forms. The most obvious forms are a diversified product range and diversified business operations; For example, a company like Lever has a diversified range of products, comprising soaps, detergents, toothpastes, fertilizers and agro chemicals. Larsen & Turbo, on the other hand, has a diversified range of business operations, including cement, manufacturing, construction and consultancy. Diversification can also be achieved through geographical dispersal of factories and markets. This protects the company from natural calamities, like floods, earthquakes, etc. which occurs only in particular parts of the country and therefore can, at worst, affect only a part of the company's operations. Some companies diversify their markets by selling their products in both domestic and foreign markets. In fact, there are numerous ways in which companies achieve diversification.

Most companies these days have shed diversification into unrelated businesses in favor of concentration on their areas of core competence. They have either sold off their less profitable businesses, or outsourced all business activities other than the one in which they have inherent strengths. For example, Lever has been systematically selling all its manufacturing units and its less profitable brands and concentrating only on what its board refers to as power brands. UT is demerging its cement unit. It has been reported in newspapers that Raymond is thinking of selling its steel unit. Companies that are industry leaders by virtue of their core competence generally make better investments than large diversified companies. The former tend to be cost efficient, dynamic and register faster growth than do diversified companies, which by and large tend to be slow and sluggish.

An investor can achieve diversification in many ways. The most obvious way is to invest in a number of well diversified companies. However, a better way to achieve diversification is to invest in a number of companies that by virtue of concentration on core competence have become industry leaders in their respective fields. Diversification of your portfolio is a compulsion that you cannot ignore irrespective of the manner in which you achieve it. Diversification not only provides safety and stability to your portfolio, it also provides you with the necessary flexibility in dealing with changing business conditions.

Companies that have concentrated on their area of core competence are, no doubt, risky investments. However, if your portfolio consists of a basket of such companies operating in different industries and in different sectors of the economy, then your risks are amply covered. Moreover, under favorable conditions these companies perform extremely well often far better than do widely diversified companies. It is only under adverse business conditions that their weaknesses are exposed. As a general rule, you should avoid investing in any company that is concentrated in a single business area unless it falls in one of the following three categories:

I . Companies whose products enjoy a monopoly or a near monopoly in the market;

2. Companies, with a captive and growing market for their products; and

3. Companies which, for one reason or another, hold a dominant position in their respective fields vis a vis their nearest competitors.