Pure Play
What Is a Pure Play?
A pure play is a company that focuses solely on one type of product or service. Some investors prefer investing in pure plays because they are easier to analyze and give maximum exposure to a particular market segment.
A pure play can be contrasted with multi-divisional corporations or conglomerates, which instead offer numerous products and services across various industries.
An investor who wants exposure to U.S. banking stocks, for example, could prefer buying shares of Bank of America (BAC) as compared to Berkshire Hathaway (BRK.B), because the latter is involved in banking as well as in numerous other industries and sectors.
Understanding Pure Plays
Pure play companies are popular with certain types of active investors who need to make specific bets on particular products or industry segments. For these investors, buying a company with several diversified business lines forces them to take unnecessary risks in industries in which they would rather not invest.
For analysts, pure plays represent an opportunity to obtain more accurate data for a comparable company analysis or peer analysis. These reports are an imperative source of data for investment analysis and the basis for relative valuations.
Relative valuations make use of metrics such as 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. Each of these values can help the investment analyst calculate the relative value of a company and to evaluate whether the company is overvalued or undervalued. Pure play companies are helpful inputs into these analyses because they are substantially more directly comparable with each other. Conglomerates, then again, are not readily comparable because their results reflect numerous industry sectors.
Realistically, the term pure play is always used as an approximation, since corporations today almost always have some amount of cross-industry exposure. This is particularly true when seeing large, publicly traded companies.
Real-World Example of a Pure Play
A trader is leading an analysis of the U.S. banking sector. Specifically, they need to evaluate the relative attractiveness of various U.S. banking stocks, based on PB and PE ratios. A list of the accompanying stocks is 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
Albeit every business is complex and unique, this analysis reveals that these four banking socks are relatively comparable to one another; since regional banking is a core focus of their business models, this is to be expected. As such, they might be viewed as "pure plays" for the banking sector.
By contrast, this same trader was tempted to include Berkshire Hathaway in the list due to its significant role in the financial sector. However, this was decided against because of Berkshire's numerous non-banking activities that made it too hard to compare directly with the banking pure plays.
Due to their dependence on one sector of the economy, one product, or one investing strategy, pure plays are often accompanied by higher specific risk. This can be mitigated through diversification.
Highlights
- A pure play refers to an investment in a company that is focused on one specific industry or niche.
- Pure plays can be challenging to identify as numerous corporations today are involved in several product lines or market segments.
- Some investors like pure plays for their ease of analysis and the exposure they offer to particular sectors.
