Diversification isn't a favorable attribute to people like Peter Lynch and other investors, who have often called it "diworsification." But the bad aspect of diversification really applies only to companies that are going on acquisition binges or are bent on expanding into new industries in which they have no experience or history.
On the flip side, customer diversification is almost always a good thing. A company that ties itself to just a few large, key customers for a big percentage of its revenue often experiences a lack of pricing power and has to do everything it can to hold onto those customers.
This lack of customer diversification has been a concern for shareholders -- or at least this shareholder -- in Income Investor selection American Financial Realty Trust (NYSE:AFR). Despite the company's 7% dividend yield and unique position in buying properties from banks and leasing them back to the banks, I haven't been willing to make the company a full position in my portfolio, simply because Bank of America (NYSE:BAC), State Street (NYSE:STT), and Wachovia (NYSE:WB) make up 78% of the company's revenues.
But in the past week, things have changed a bit at this highly focused REIT. By adding Wells Fargo (NYSE:WFC), Royal Bank of Scotland, and fellow Income Investor pick National City (NYSE:NCC) to the customer roster, the company has begun to accomplish some much-needed diversification. And these customers are all high-quality partners.
Let's not forget that American Financial Reality still has all the competitive advantages we've outlined in the past, such as tenants with excellent credit ratings and the lack of a true competitor. It also doesn't hurt that the company holds high quality assets and is well diversified from a geographic perspective. But now we get all this and a free dinner, too. Well, OK, there's no free dinner, but you get the point: The company has only improved its footing.
American Financial was not in the same danger as some small vendors are when pinning all of their hopes on a large company such as Wal-Mart (NYSE:WMT), but it faced some very real risk if one of its big three customers had defaulted. With the new, strong customers on American Financial's portfolio, I know I'll be taking another look at how the company fits into my portfolio. I'll hold off for a bit, but who knows -- I may just make a change myself.
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Fool contributor Nathan Parmelee owns shares of American Financial Realty Trust and National City. The Motley Fool has a disclosure policy.
