What’s Corporate Diversification Got to Do With It?
Key findings
- We mapped companies’ operations using MSCI Business Segment Data to their respective sub-industries across four global regions and found shared investment characteristics that aligned with corporate-diversification level.
- Our findings suggest that corporate diversification could be a key dimension in global equity investors’ decision-making around managing portfolio exposures to certain factors, sectors and fundamentals.
- Corporate diversification has declined markedly since the 1980s, resulting in a shift toward more pure-play companies. This research can help investors better understand how corporate diversification can impact firm characteristics.
A wave of "deconglomeration" in the 1980s, motivated by a belief it would enhance shareholder value, swept many diversified companies into corporate specialization, particularly in the U.S. In the wake of the pure-play trend, we examined how firms along the diversification spectrum have performed; their regional and age distributions; and their exposures to certain factors, sectors and fundamental metrics. Although diversified firms have tended to efficiently leverage their assets and mitigate market risk, in the five years ending June 28, 2024, they lagged the profitability and growth of their single-industry counterparts. Our findings underscore corporate diversification as a key decision-making criterion for global equity investors.
So, how do we define diversification?
We categorized the firms in the MSCI ACWI Investable Market Index (IMI) into one of three groups — single-industry (firms that generate all their sales from one GICS® sub-industry), moderately diversified (more than one and less than two sub-industries) and diversified (two or more sub-industries)[1] — and one of four geographic regions: Japan, U.S., emerging markets (EM) and the rest of the world (RoW).[2] We leveraged MSCI Business Segment Data to map a company's individual business segments or divisions to sub-industries, the most detailed level of the Global Industry Classification Standard (GICS®), as of June 28, 2024.[3] This overlay forms a standardized and simplified approach to classifying a firm's operations, whether measured by sales, assets or operating income, to determine its level of diversification. For example, based on revenue measures, our approach categorizes Apple, Alphabet and Home Depot as single-industry; Amazon, Meta and ExxonMobil as moderately diversified; and Berkshire Hathaway, Shell and LVMH as diversified.
Pure-play firms outnumbered multi-industry in the US and EM
By count, single-industry firms dominated in most regions, especially in the U.S., where they composed 69.1% of the U.S. equity market as of June 28, 2024. Japan, in contrast, had the highest share of multi-industry (diversified and moderately diversified) firms, composing 54.2% of the firms by count and 62.9% by market capitalization. Approximately 21.5% of the 2,730 firms that derived revenue from more than one sub-industry in the MSCI ACWI IMI were based in the U.S., with Japan ranked second at 16.2%.[4] Collectively, East Asia — encompassing the Japanese keiretsu, Chinese jituan, South Korean chaebol, Taiwanese guanxi qiye and Indian conglomerates — accounted for much of this group, some 44% of the total firm count.[5]
Regional distribution of single- and multi-industry firms
Sector distribution within the diversified category
Data as of June 28, 2024, based on constituents of the MSCI ACWI IMI.
Across regions, diversified firms were more often in the industrials sector, particularly in Japan and EM, at 37.1% and 30.5% of firms, respectively. In the U.S. and EM, on a market-capitalization basis, the financial sector was the most common, with weights of 52.3% and 23.6%, respectively.
Seeking a certain factor exposure? Diversification could play a role
We can break down how diversification has impacted exposures to valuation, growth, quality and volatility. In a nutshell, single-industry firms had higher growth and quality characteristics and more expensive valuations, whereas multi-industry firms were stronger on volatility metrics.
Quality. Single-industry firms ranked higher on quality characteristics than their multi-industry counterparts across most regions. Diversified firms exhibited the weakest quality characteristics, particularly in the U.S. and EM.
Largest divergence in quality metrics of pure-play vs diversified firms was in US and EM
Amounts represent the five-year annual average factor exposures between June 2019 and June 2024. Exposures are calculated based on MSCI's FaCS® methodology.
Diversified firms, especially in the U.S., had lower profitability and used more leverage, which weakened their quality profile. They did register positive exposure to investment quality, likely driven by their lower share issuance and increased participation in share-buyback programs, compared to their single-industry counterparts.
Growth. Diversified firms typically delivered lower growth compared to the dedicated pure-play peers across all regions, but notably so in the U.S., where they posted a significant negative exposure to the growth factor.
Growth metrics stronger across all regions for single-industry firms
Value. Aligning with the concept of a "conglomerate discount," multi-industry firms had lower valuations than their single-industry peers across all regions.
Single-industry firms had higher valuations than multi-industry firms
Amounts represent the five-year annual average factor exposures between June 2019 and June 2024. Exposures were calculated based on MSCI's FaCS® methodology.
We evaluated the value factor's core components using the MSCI global-equity risk model (EFMGEMLT) and observed a consistent pattern across regions, including Japan: Firms in the diversified category displayed above-average book-to-price and earnings-yield ratios.
Volatility. One motivation for companies to develop and maintain business lines in different sub-industries could be to seek greater financial resiliency over a range of market and macroeconomic conditions. We found that diversified firms had lower stock-price volatility compared to pure-play single-industry firms across all regions.
Multi-industry firms were less volatile than their single-industry peers
Amounts represent the five-year annual average factor exposures between June 2019 and June 2024. Exposures were calculated based on MSCI's FaCS® methodology. The regional variation in volatility exposures, regardless of the diversification bucket, reflects the global standardization of volatility exposures as opposed to within countries.
The largest reduction in exposure to market fluctuations occurred for multi-industry firms in Japan and the U.S., based on their beta exposures. Idiosyncratic risk (residual risk to market beta) was also typically lower for multi- versus single-industry firms.
Pure-play or multi-industry? Each has its own strengths
Companies with operations in multiple industries have tended toward lower valuations, slower earnings growth and weaker quality, but greater resilience across business cycles as demonstrated by lower volatility and broader geographic-revenue streams. Single-industry firms, in contrast, were generally more profitable with faster earnings growth, but had limited geographic-revenue exposures. Understanding a firm's diversification profile can shed light on its likely strengths and weaknesses.
1 We used the Herfindahl-Hirschman Index (HHI) applied to shares of revenue to determine the effective number of sub-industries in which a company operate. Given our thresholds of one and two sub-industries, a company with 98% revenue from one sub-industry and 2% from another is categorized as a moderately diversified company. To account for marginal cases and assess their impact on the results, we conducted every analysis with two additional sets of thresholds: 1.05 and 2.1, and 1.1 and 2.2. The results from either of the three sets of thresholds were consistently aligned.2 RoW corresponds to all developed markets (MSCI World Index) except the U.S. and Japan.3 GICS is the industry-classification standard jointly developed by MSCI and S&P Global Market Intelligence.4 The U.S. equity universe is significantly larger than many other single-country equity markets, which explains why it has the largest number of multi-industry firms. However, the U.S. does not lead in terms of index weight.5 Keiretsu (Japan), jituan (China), chaebol (South Korea) and guanxi qiye (Taiwan) are all terms commonly used for business groups in different parts of East Asia. Historically, these groups have been characterized by cross-shareholdings and close-knit networks of affiliated companies. A similar structure existed in Germany with the so-called Deutschland AG (Germany Inc.), a network linking large banks, insurance companies and industrial firms. However, due to changes in tax policies and the rise of institutional investors in recent decades, these cross-shareholding arrangements have largely disappeared.
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