Pure Play: Examples of Niching Down in Investing

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 many products and services across various industries.

An investor who wants exposure to U.S. banking stocks, for example, might prefer buying shares of Bank of America (BAC) as compared to Berkshire Hathaway (BRK.B), because the latter is involved not only in banking but also in many other industries and sectors.

Understanding Pure Plays

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 forces them to take unnecessary risks in industries in which they do not want to invest.

For analysts, pure plays represent an opportunity to obtain more accurate data for a comparable company analysis or peer analysis. These reports are a vital source of information 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 much more directly comparable with each other. Conglomerates, on the other hand, are not readily comparable because their results reflect numerous industry sectors.

Real-World Example of a Pure Play

A trader is conducting an analysis of the U.S. banking sector. Specifically, they want to evaluate the relative attractiveness of various U.S. banking stocks, based on PB and PE ratios. A list of the following 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

Although every business is complex and unique, this analysis reveals that these four banking stocks 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 may 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 difficult to compare directly with the banking pure plays.