As you get started in the world of investing, you’ll learn that there are several different types of stocks out there. One commonly discussed type is the pure-play stock.
With a name like “pure,” you might think there’s no way you can go wrong with these stocks. But being a pure-play stock doesn’t mean the company enjoys pure revenue growth or pure profits, or that it’s risk-free. In pure-play stocks, the term “pure” has more to do with the company’s focus than with its fundamentals.
What Are Pure-Play Stocks?
Investors often look for companies with diverse revenue streams. For example, tech investors tend to like the fact that Facebook owns dozens of subsidiaries, offering revenue streams outside of its core social network. The same can be said for Google and Amazon. If something goes wrong somewhere, these companies can build upon another area of the business to make up for losses.
Pure-play stocks are very different.
Pure-play stocks represent companies with a singular focus. Instead of building out multiple revenue streams, these companies concentrate on a single product or service. The aim is to give the company the ability to create the best in their class of product or service and corner the market. As a result, they won’t need diversified revenue streams to maintain growth.
Food producer Beyond Meat is a great example of a pure-play stock. The company has no subsidiaries and focuses on only one line of business. Instead of providing food in all categories, Beyond Meat only offers plant-based food products designed to mimic the look, texture, and taste of real meat.
The company’s singular focus has led to incredible success. It’s given it the ability to create a product that has caught the attention of fast-food chains like Hardees, Del Taco, and Carl’s Jr. At the same time, sit-down restaurants like TGI Fridays and Denny’s have started to offer Beyond Meat alternatives to some of their most popular menu items.
Ultimately, a pure focus on a single product or service can have its benefits. But it can also have its drawbacks.
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Pure-Play Stocks: Pros and Cons
There are obvious advantages to a singular focus. Think of it in medical terms. If you need back surgery, you want a specialized surgeon who focuses on patients with back injuries. This singular focus gives you the peace of mind that the doctor cutting into you knows what he’s doing.
The same could be said about the value of a singular focus in the business world. However, reward never comes without risk, and there are pros and cons to everything.
Pure-Play Stock Pros
There are several benefits of investing in pure-play stocks. Some of the most important include:
- Best-in-Class Products. Pure-play stocks tend to have the best of the best when it comes to product offerings. Because they’re so focused on a single product or service, it becomes second nature for them to produce the best. For example, at one point in time, BlackBerry was a pure-play stock. The company only offered cellphones, and those phones became a symbol of who was hot and who was not. In fact, it was the BlackBerry smartphone that paved the way for high-end smartphones as we know them today.
- Easy to Assess. Investing is all about an educated prediction of the value of an asset in the future. It takes quite a bit of work to assess multiple products across multiple markets, as is necessary when analyzing a publicly traded company that’s highly diversified. Analyzing pure-play stocks is a different process. These stocks have a single product in a single market, so the market opportunity is relatively easy to gauge. The same can be said for assessing the success of the company relative to its peers.
- Industry Correlations. Pure-play stocks are generally heavily correlated with the industry in which they work. For example, Chipotle has a singular focus on fast-casual Tex-Mex dining, making it a pure-play in the fast-casual dining industry. As such, when consumer demand for dining out increases, it’s natural to see gains in the price of Chipotle shares. These correlations between pure-play stocks and the industries they represent make analyzing these opportunities even simples.
Pure-Play Stock Cons
Although there are plenty of benefits of investing in pure plays, there are also several risks unique to this class of stocks. Some of the most important risks to consider include:
- A Competitor Taking the Lead. Just because a pure-play stock is at the top of its game now, there’s no reason to expect the company’s leadership will continue. BlackBerry was a pure play in smartphones, and then Apple took the smartphone market by storm, leaving BlackBerry in the dust. This led to a tremendous decrease in the value of BlackBerry shares, which have fallen from more than $138 per share in 2008 to single digits today. Ultimately, when a company has a singular focus, it must stay on top of its industry to maintain its position as a viable investment opportunity.
- Industry Correlations. While industry correlations can have their benefits in pure-play stocks, they can also lead to serious pain. For example, if the value of oil falls, pure-play energy-sector stocks feel the pain. Because they put all of their eggs in the energy basket, they have nothing to fall back on when the price of their flagship commodity goes down the drain. The same could happen to Chipotle Mexican Grill if consumers start to veer away from fast-casual dining.
- A Key Product Failing. There are several pure-play stocks that don’t yet have products on the market. For example, the biotechnology company MannKind invented a product known as Afrezza, an inhaled insulin that was intended to free diabetics from the need for injections. When the product was under development, the belief was that it would fly off of the shelves. However, when it finally launched, its sales disappointed and the manufacturer terminated its production. As a result, the stock plunged from over $50 per share in 2014 to today’s value of just under $2 per share.
What to Look for in Pure-Play Stocks
While pure-play stocks come with risks, it’s hard to ignore their benefits. If you plan on dabbling in the pure-play investing world, you’ll need to know what you’re looking for. As you analyze opportunities, keep an eye out for the following:
- A Commercialized Product. It’s best to avoid pure-play stocks that don’t yet have a successful product on the market. These stocks tend to be highly speculative and trade in the penny-stock category. Without a product on the market, these companies generally bleed through cash on hand and rely on transactions that aren’t in the best interest of investors to stay alive. So, the first rule of thumb is to make sure the product is already on the shelves.
- Intellectual Property. When it comes to pure-play stocks, intellectual property is key. Patent, copyrights, and trademarks can make the difference between a stock that loses and a stock that wins. Ultimately, pure-play companies only have one focus. If they don’t legally protect the fruits of their investment dollars and research, another company can steal their concepts, sell their products at a discount, and leave them with nothing. Always make sure the company you’re interested in investing in has the legal documents it takes to protect their hard work.
- Growing Sales. One reason you only want to invest in pure-play stocks with a product on the shelves is so you can see how well that product is doing. Take the time to dig through recent financial reports and pay close attention to the sales line item. For a pure-play stock to survive, it needs to have an overwhelmingly successful product that keeps customers coming back. As such, strong investments in this sector will see consistent increases in sales quarter over quarter. Any quarterly decline in sales over the past two years serve as a red flag for the future.
- Scalability. For a pure-play stock to be successful, the masses need to take interest in the company’s products. That means the company must have the ability to scale production up to meet large-scale demand. Take a moment to research the scalability of the company’s manufacturing process. If you find any issues with it, it’s best to avoid that investment.
- Market Potential. It’s relatively easy to gauge the market potential of a pure-play product. Start by researching the size of the market for the category of the company’s primary product. For example, if you’re considering GoPro as an investment, look up the size of the action camera market. Once you know the size of the entire market, find out what share of the market the company you’re interested in controls. If the company controls more than 25% of the market and the market seems to be growing, you’ve found a pure-play stock with great potential.
Who Should Invest in Pure-Play Stocks?
In the world of investing, there’s no such thing as a one-size-fits-all option. Those who should consider investing in pure-play stocks display the following characteristics:
- A Healthy Appetite for Risk. Although pure-play stocks are relatively easy to analyze, they aren’t always the best investment options. Pure-play stocks come with risks not seen among stocks with diversified revenue streams. There is always the chance that something will happen to the company’s central product or industry that will lead to dramatic declines. If you’re going to get involved in a pure play, make sure you always consider the risks.
- The Ability to Act Quickly. When something goes wrong in a pure-play investment, it tends to happen fast. When Apple overtook BlackBerry in the smartphone sector, BlackBerry’s stock gave up two-thirds of its value in a matter of a few months. Investors in pure-play stocks need to be prepared to act quickly when the situation changes in order to cut losses before they get too painful.
- A Willingness to Keep a Watchful Eye. When investing in pure-play stocks, investors should be dedicated to paying attention to what’s going on. In particular, investors should read every press release and quarterly earnings report and thoughtfully consider how the news affect will the company’s bottom line in the long run. Because pure-play companies can’t fall back on diversified revenue streams, it’s important that investors in them make sure these companies are on the right track with their main product line.
Pure-play stocks attract many newcomers to the world of investing because of the simplicity involved in analyzing these opportunities. However, simple analysis doesn’t always equate to a big win in the stock market.
It takes a specific type of investor to be successful when investing in pure plays. You must understand the risks, be diligent in your research, and be ready to act decisively in the face of changing circumstances to cut losses or save profits.
While investing in any stock is not for the faint of heart, investing in pure-play stocks can become trickier than it seems over time. With that said, if you do decide to try your hand in the pure-play space, make sure to do your research.
Also, never dive into a new investing concept headfirst. Set aside a small percentage of your investing capital, and use it to try your hand in the world of pure plays. If it works out for you, you always have the opportunity to adjust your portfolio for more pure-play moves in the future. However, if it doesn’t, you haven’t risked enough of your portfolio to lead to substantial losses.
Have you ever invested in pure-play stocks? Would you rather invest in a pure play or a diversified company?