The significant valuation impact of diversity to listed companies

I have always emphasized in the book “The Rules of Super Growth Stocks Investingrowth Stock Investment Rules” that investors do not like all kinds of uncertainties. They like that revenue can be predicted, revenue and profits are easy to estimate, and it is best to have any listed company that has fairly stable growth.

As long as the companies that meet these conditions are dream-like listed companies that Wall Street dreams of; their stock prices must be highly sought after. But in reality, those who can always maintain these strict conditions can be said to be rare — this is the most obvious difficulty for investors. Let me use the following three perspectives, supplemented by multiple examples to emphasize the importance of “business diversity” in stock price and valuation.

Table of Contents

Variety of products

I compare it with Apple, and everyone will understand it better. Microsoft (ticker: MSFT) and Apple (ticker: AAPL) are both heavyweight listed companies in the US stock market, and are currently the only two listed companies that have achieved a market value of US$ 2 trillion US. They have been listed for about 40 years, and both have allotted dividends. They are the only minority distributing dividend among the five major technology stocks in the U.S. stock market. It is also the listed company with the most Wall Street analysts tracking in US stocks today.

However, Apple’s stock has long been far less optimistic than Microsoft’s. As long as you look at the resilience, support, and stability of Microsoft’s stock price, you can know how optimistic the majority of investors are about the Microsoft stock! In addition to the comparison of the three reasons I analyzed in the entire section 2-2 of my book “The Rules of Super Growth Stocks Investing” — there is another main reason that is the “Diversity” of the product. Don’t forget that Apple’s revenue, and net profit are much larger than Microsoft’s, and its business growth rate is also higher than that of Microsoft.

Apple has always had the curse of the iPhone. A few years ago, the iPhone even accounted for 70% of the company’s total revenue. Until recently, Apple successfully manage to make this ratio less than 50%. (In the second quarter of 2021, iPhone revenue was 39.57 billion U.S. dollars. Accounted for 48.61% of overall revenue). Even so, it still accounts for an absolute proportion of half of the company’s total revenue. Unlike Microsoft, Microsoft Office office software accounts for 24.69% of company total revenue, and Windows operating system account for 15.59% of total revenue.

Fifteen years ago, the status of Microsoft Office software in Microsoft was the same as that of iPhone to Apple today. At that time, Microsoft product lines, except for Microsoft Office and Windows, were not as diverse and powerful as they are today. You can look at Microsoft’s stock price at that time. The company’s revenue has stagnated almost for nearly a decade, and the stock price is even lower than the performance of other competitors. For details, please refer to my book “The Rules of Super Growth Stocks Investing” 5-4 Section; the company’s stock price actually fell by 21.9% in the six years from 2001 to 2006!

Another very good company is Adobe (ticker: ADBE). I mentioned this company many times in my book “The Rules of Super Growth Stocks Investing”, and I also discussed why Adobe is so successful. Its stock price has skyrocketed in recent years except for the unwritten standards in the multimedia industry that I mentioned in my book (section 2-3 in the book), and the success of cloudification and subscription license model (section 3-3 in the book); The other big reason is also the diversity of products. Due to space limitations, no further discussion will be conducted. Please see my previouse post “How Adobe makes money?“

Another company that has been very successful recently are Texas Instruments, please see “How does Texas Instruments make money? Amazing long term capital reward and company net profit margin!” and Qualcomm, please refer to my other article “Qualcomm diversifies success, no nonger highly dependend on phone” for details.

Are there any famous but failed examples? Coca-Cola (ticker: KO) is a classic example of a failure. Please see my post “Pros and cons of investing in Coca-Cola“

Customer diversity

Another thing that Wall Street pays the most attention to is the diversity of customers. In the book “The Rules of Super Growth Stocks Investing”, section 4-1, I cited Applied Optoelectronics (ticker: AAOI) because the largest customer switched to its rival, then the stock price collapsed by 29.38% in one day. As long as any customer accounts for more than 10% of annual revenue, investors should be more vigilant.

Marqeta (ticker: MQ) went public in June this year. The financial report and operational data are actually not bad. Revenue growth is still very good (123.2% annual growth in the first quarter of 2021, 102.6% growth in 2020). It has fallen all the way in past four months and has fallen by 31.13% so far, showing no improvement! The main reason is that as much as 70% of the company’s revenue in 2020 will come from Block (ticker: SQ). Investors can be frightened to look at this number; regardless of other aspects of performance are above the standard, and even some are excellent, it is all useless.

Another example is that it went public in January this year, and now the most popular BNPL company Affirm (ticker: AFRM). It was listed in mid-May, in less than four months, it fell by 50.26% all the way. The company’s stock price has not rebounded significantly until Amazon recently established a partnership with it. There is no reason, because Affirm disclosed in the listing prospectus S1 that in 2020, the revenue from a company Peloton (US stock code PTON) accounted for 30%!

Regional diversity

Regional diversity includes whether the company’s customers are over-concentrated in a certain country or region, and whether the company’s production is subject to a certain manufacturer (this situation is less likely to happen under capitalism), or even over-concentration in a certain one areas-no matter what, for a listed company, it is extremely dangerous.

Take Apple as an example. So far there are more than 200 manufacturers listed in its supply chain, including more than 800 locations and manufacturers. Of course, most of them are located in Fareast including China, Taiwan, South Korea, and Japan; especially China manufacturers, starting from 2020, have replaced Taiwan and become the source country of the most suppliers (even Taiwanese suppliers, most Taiwanese and some Japanese and Korean manufacturers have factories in China.

This is a well-known situation, not a secret.) Of course, Apple understands its dangers. Two or three years ago, it began to actively force its manufacturers to move their factories out of China as much as possible in order to diversify risks.

But from the current point of view, Apple’s action has not been successful, and even many manufacturers have moved their production lines back to China. I personally think that the main reasons are:

The upstream and downstream of China’s supply chain, after more than 20 years of construction, the industrial chain is complete, and it is impossible to find a replacement country. Almost no impact on business activity and factory manufacturing if compare to other major countries
With the outbreak of COVID-19, China is the only major countries with positive economic growth in 2020, and the pandemic has been successfully controlled.
The hard-working nationality of the Chinese, productively, high-quality workers (I’m quoting Cooke’s term).

In addition, Trump began to impose a Chinese embargo starting 2018; it is the US manufacturers that have suffered the most. In the semiconductor industry, Qualcomm (ticker: QCOM) has publicly stated that more than 70% of the company’s revenue comes from mainland China. Intel (ticker: INTC) and nVidia (ticker: NVDA) have both announced that both are more than 30%, Texas Instruments (ticker: TXN) is more than 55%, and laser developer IPG Photonics (ticker: IPGP) is 42% .

China accounts for at least 30% of the revenue of other important semiconductor companies. As for the impact on other U.S. businesses, you can refer to my other blog article “The importance of the Chinese market: more than 10% of listed U.S. companies and 14.98% of Taiwanese companies’ income comes from China“

A note

When companies are chasing business diversity; Munger reminds investors that companies are most likely to fall into the “Institutional imperative“ effect pointed out by Buffett because of the management team, and fall into the internal friction competition of mutual comparison. What he quoted is the so-called “Diworsification” Peter Lynch wrote in his famouse book “One up on Wall Street“, as a result, is to satisfy the CEO’s great joy.

Not only does it help the business, “mostly” it will weaken the company’s competitiveness and deplete the company’s resources. From then on to the slope; therefore, investors must open your eyes to see clearly and distinguish clearly; in the end, there are very few that can really succeed. As long as you go back and check the stock price trend of these semiconductors in the second half of 2018, you can know how big the impact is. The successful case company achieve business diversity is quite rare, keep this in mind!

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