Investing in Pure-Play Companies

I've written before about the advantages of concentrated or "focused" investing.  Focusing your investing attention and dollars just makes good sense -- why spread your money over your best ideas and your not-so-best ideas? Why not just keep it in your best ones?

There are lots of ways to focus your investing. You might invest in just eight to 12 companies, for example. If you do this, though, you should be very familiar with the companies and follow them closely -- after all, a good chunk of your net worth is riding on their performance.

Those who don't have the stomach -- or time, or skills -- for that can opt to invest in focused mutual funds, where the managers don't spread shareholder money too thinly. The upside here is that if the managers are effective, picking great performers, the fund is likely to outperform other funds that hold 200-plus different securities. The downside is that if the managers' picks don't pan out, the fund will suffer more than its broader peers. Similar to investing on margin (i.e. investing with borrowed money), focused investing can amplify both gains and losses.

Here are some well-regarded focused funds you might want to consider:

Source: Morningstar.

Another way
There are other ways to focus your money, though. One is by seeking out "pure-play" investments: companies that have a single business focus. Best Buy, for example, is a pure play in electronics retailing, and that's pretty much all it does. You can also purchase all kinds of electronics at Sears, but you'll find them amid clothing, tools, auto parts, and a myriad of other items. In other words, Sears isn't an electronics pure play.

If you're looking for a computer pure-play company, you might consider Dell -- but not Best Buy. Best Buy does sell computers, but it also sells telephones and televisions and DVDs.

Coca-Cola (NYSE:KO) is a beverage pure play, while PepsiCo (NYSE:PEP) isn't, because it gets a big part of its sales from Frito-Lay snacks, featuring such brands as Lay's, Ruffles, Doritos, Tostitos, and Cheetos. By way of illustration, PepsiCo has recently earned more revenue from its Frito-Lay salty-snack unit in North America than it has from its beverage operations.

On the other hand ...
Of course, maybe you don't want to focus so much. There is an upside to diversification: it can protect your portfolio's earnings. If one of your stocks craters, it will make a big dent in your portfolio if it represented 20% of it. But if it was just one of 50 holdings, holding just 2% of your portfolio's assets, then its crash won't be so noticeable.

This is the kind of concern that can make some people avoid pure plays. It's what can lead them to companies such as General Electric (NYSE:GE), a company which is about as far from a pure plays as one can get. It might be easier to list businesses GE is not involved in, dealing not only in light bulbs and appliances, but also in credit, aviation, energy, broadcasting, security, water, health care, railroads, marine engines, telephones, digital cameras, solar power, wind power, nuclear energy, and chemicals. Phew!

Putting it all together
So how should you go about your investing? Should you focus or not? Well, it really depends upon your preferences. You should read more about concentration and consider it carefully: Concentrated portfolios may be more volatile, but they'll often outperform broader funds.

As Whitney Tilson (who runs a concentrated mutual fund, himself) put it, "It seems so obvious that it makes more sense to buy more of your best idea than add a 100th position to a 99-stock portfolio, yet the average mutual fund holds more than 100 stocks. In almost all cases, this is foolish 'deworsification' and reflects closet indexing rather than prudent money management."

It is also possible to combine both focused and diversified approaches. If you hold 15 different stocks in a wide range of industries, with each company having only one or two business focuses, then you're both focused and diversified.

If finding pure-plays is tough, you don't have to search in the market wilderness alone. We'd love to help by inviting you to try our Motley Fool Hidden Gems newsletter services, free for 30 days. There you'll find some promising stocks, many with single business focuses. Hidden Gems seeks out and recommends companies that are not too big and that our analysts think are undervalued, which means that they may have a heck of a lot of room to grow.