Pure play stocks represent publicly traded companies that focus on a single line of business. While other companies may diversify their business operations, pure play companies focus on selling a single product or service. So what does this mean when holding pure plays in an investment portfolio? This type of stock can offer both advantages and disadvantages to investors, like any other type of security. Specifically, it’s important to understand how these companies derive their revenue and profit and how they’re likely to react in changing market environments.
Deciding which types of securities to invest in can be complicated so it’s wise to avail yourself of the insights of a financial advisor.
What Is Pure Play in Investing?
A pure play refers to a company that’s publicly traded on a stock exchange and focuses on just one line of business. That means they offer just one product or service, which is central to driving revenues. So, for example, a company that only sells high-end luggage or a restaurant chain that’s known for selling a specific type of cuisine could be considered a pure play.
Pure plays are the opposite of companies that have diversified revenue streams. For example, a discount retailer like Target or Walmart makes its money by selling a wide variety of products. E-commerce stores could also fit into this category if they sell more than one product.
What sets these companies apart is the fact that revenue isn’t dependent on a single product or service. If one product line lags behind, for instance, revenues may take a small hit. But the success or failure of the business isn’t necessarily dependent on that one product. With pure play companies, success is more closely tied to the company’s main product or service.
Advantages of Pure Play Investments
Investing in pure plays can offer some advantages to investors who are interested in companies that concentrate on a single product or service line. Here are some of the potential upsides that are associated with investing in pure plays:
- Easier to analyze. When researching stocks, there are different indicators investors can use, including fundamentals and technical indicators. While they can help with making informed investment decisions, it can be easy to get bogged down in the numbers. Pure play investments, on the other hand, are easier to analyze because they have a defined focus. For instance, it’s easier to compare two pure play companies in the same industry that sell similar products.
- Higher profit potential. Investing in pure plays could benefit investors from a returns perspective. If the company associated with a particular product or service is considered to be an industry leader, that increases the likelihood that revenues will remain consistent over time or increase. That could lead to higher returns for investors as well as regular dividend income from pure play companies that offer dividends.
- Align investments with values. If you follow environmental, social and governance (ESG) principles or a socially responsible investing (SRI) strategy, there may be certain companies or industries you’d rather avoid. With pure plays, there’s greater transparency in terms of what the company does since they just have a single product line. With a company that has dozens or even hundreds of subsidiaries, it may be harder to sort out which ones most closely mirror your values.
Disadvantages of Making a Pure Play
Pure play investments aren’t perfect and there are some potential drawbacks to consider. Here are some of the potential disadvantages to keep in mind:
- No diversification. Pure plays by nature are not diversified. That means a pure play company’s fortunes could rise or fall based on the success of their product. If something happens to disrupt supply chain lines, for example, that could spell trouble if the company isn’t able to get their product to the market. Or in the case of a private company that’s planning to launch an initial public offering (IPO), there’s always the risk that the product – and the IPO – will flop.
- Market volatility. A pure play investment can also be threatened by market volatility, but perhaps even more so if volatility is centered on the company’s industry. So again, say you have a company that produces high-end luggage. If the economy is easing into a recession, then people may direct more of their spending to consumer staples and away from discretionary items like travel. So there may be less demand for the company’s luxury bags and thus, fewer profits.
- Competition. Another threat to pure play companies has to do with the competition. Say there’s a company that produces a very popular type of reusable water bottle. But a new startup comes along that offers a similar reusable water bottle and thanks to its marketing efforts, it becomes an overnight sensation. If that company’s popularity ends up being temporary, then there may not be anything to worry about for the first company. But if that new company begins to take over the market, that could put a damper on the first company’s sales. And that could mean fewer profits for investors who hold shares in it.
How to Invest in Pure Play Stocks
Investing in pure play stocks starts with understanding what your goals are and what type of companies you’d like to target. For example, if you follow a growth strategy then you’d want to look for pure plays that have solid growth potential. If you’re a buy and hold investor or a value investor, then you’d likely want to look for companies that have the best prospects for long-term price appreciation.
Fundamental analysis and technical analysis can be helpful when choosing pure plays. Fundamentals refer to the various metrics that are used to gauge a company’s underlying financial health. So you may look at price-to-earnings ratio (P/E) or earnings per share (EPS), for example. Technical indicators focus on how a stock is trending now and where it’s likely to go next. So you may be looking at moving averages instead to gauge price momentum.
What’s also important is to consider the company’s positioning within their respective industry. Are they at or close to the top of the pack, in terms of their product line’s popularity and revenues? How old is the company and who are its biggest competitors? What kind of room does the company have to grow? How does the stock market sector the company belongs to typically react during periods of economic expansion and contraction? How does it fare during a recession?
Asking these kinds of questions can help you identify pure plays that have a higher degree of staying power. It can also be easier to determine which companies to buy or sell if you follow a sector-based investing strategy. Sector-based investing advocates buying and selling securities to keep pace with changing markets and business cycles.
Once you’re ready to invest, you can open an online brokerage account if you don’t have one already. When comparing online brokerages, check the fees you might pay and the range of investment options. Also, consider the minimum investment you’ll need to make to get started.
Pure play investments can be attractive to investors who are interested in companies that are easier to research and may yield higher returns. Or such investments may appeal to investors with a high degree of confidence in whatever singular product or service a company may be selling. When considering pure plays, keep the larger asset allocation picture in mind. This is key to ensuring that your portfolio remains diversified and aligned with your risk tolerance and goals.
Tips for Investing
- Pure plays can be profitable but they can also entail higher risk owing to their narrower focus. They also require investors to be more hands-on, as pure plays may be more sensitive to rapidly changing market conditions. If you’d prefer to be more hands-off or you’d like to hold multiple pure plays in a single basket, you may consider a pure play exchange-traded fund (ETF) versus buying individual stocks. These ETFs give you exposure to different pure play securities, allowing you to spread out risk in your portfolio.
- Consider talking to a financial advisor about the pros and cons of pure play investing. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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