X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Diversification Leading to Billions in Losses - Views on News from Equitymaster
  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Diversification Leading to Billions in Losses
Jul 7, 2016

How often you see big companies diversifying into un-related businesses. Once the company turns big, the growth becomes stagnant on account of a higher base. Then, to spur growth, the company diversifies.

Big companies have enormous cash piles with which to diversify. However, in most cases, the diversification strategy goes wrong and leads to a huge erosion of cash from the balance sheet.

A better use of this cash would be to distribute it to shareholders as dividends.

Let's go through a few of the many examples of diversification leading to 'diworsification'. This term was mentioned by legendary investor Peter Lynch in his book, One up on Wall Street. In that book, Lynch explains the enormous risks of diversifying into unrelated businesses.

Kingfisher Airlines (KFA) is the perfect example. While the liquor business was doing well for the company, the promoter decided to foray into the aviation space...and throw good money after bad.

Reportedly, United Breweries, the holding company of the airlines, ended up lending and giving guarantees of Rs 120 billion to KFA. KFA went bankrupt in 2012, and there was hardly anything that United Breweries could recover.

The market capitalisation of United Breweries has fallen 90% since then, representing massive wealth destruction for minority shareholders.

And now the promoters of VRL logistics have expressed their desire to foray into the aviation business. Now, this is a completely different business for the promoters. When asked by an interviewer regarding the dissent from the minority shareholders, the promoter said, 'I am not bothered about shareholders.' The stock dropped 30% in two days, destroying shareholder wealth.

Another example is Unitech entering the telecom business. Real estate used to be its core business. The massive losses in the telecom space coupled with a huge debt taken for the telecom spectrum, forced the company to sell its core assets (including its headquarters) to repay the debt.

The return on capital employed (ROCE), which was as high as 22% before the telecom acquisition, dropped to a mere 6.6% post the acquisition. And the cash on the balance sheet too dropped from Rs 14 billion to Rs 3.7 billion.

We could keep going with these examples, but the point is one should be very careful while putting their hard earned money in companies looking to diversify into new businesses. The promoters' overambitious dreams coupled with the deployment of excess cash into unrelated business can erode tremendous wealth.

Rohan Pinto

Rohan Pinto (Research Analyst), Managing Editor, ValuePro and Smart Money Secrets, holds a bachelor's in engineering and a master's in finance. He is a practitioner of value investing philosophy inspired by Warren Buffett and Charlie Munger. Being a voracious reader, Rohan believes in the philosophy of mastering the best of what other people have already figured out. In his pursuit of worldly wisdom, he has constructed a multidisciplinary mental models framework, which he believes aids in effective decision making. His search for outstanding stocks is driven by a relentless pursuit of learning from the greatest living investors and the eminent dead.

Equitymaster requests your view! Post a comment on "Diversification Leading to Billions in Losses". Click here!

1 Responses to "Diversification Leading to Billions in Losses"

ANAND RAMPURE

Jul 8, 2016

This article on diversification by Rohan Pinto was a very relevant information for investors like me. It goes to show that trying to venture into the areas which are not our strong point can have disastrous outcome. Reliance is one more such example. Going long on those companies who perform in limited areas of thier expertise, not trying to experiment too much, giving dividend to shareholders promptly and improvise further in thier own speciality to be competent and to have an edge over other competitors in the same field.

Like 
  
Equitymaster requests your view! Post a comment on "Diversification Leading to Billions in Losses". Click here!

More Views on News

What They Forgot to Tell You About Sensex at One Lakh (Smart Contrarian)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

Venezuela's Own Crypto Currency: Smart or a Sham? (Outside View)

Feb 21, 2018

The South American nation of Venezuela just launched its own cryptocurrency. Is this the beginning of a revolution? Read on to find out more...

Safe Stock Ideas for You from Monday to Friday (The 5 Minute Wrapup)

Feb 21, 2018

The 5 Minute WrapUp will now come to you every weekday.

Narrow Banking: Public Sector Banks Should Not Be Lending to Corporates (Vivek Kaul's Diary)

Feb 21, 2018

Corporate bad loans constituted nearly 70% of the total bad loans of public sector banks in India, in 2016-2017.

More Views on News

Most Popular

Follow India's Super Investors to Make Big Money in the Market Crash(The 5 Minute Wrapup)

Feb 8, 2018

Has the sell-off in the markets left India's super investors unduly worried?

The Era of Easy Money is Coming to an End. What Happens Now?(Vivek Kaul's Diary)

Feb 9, 2018

The easy money policy of the Federal Reserve of the United States, which drove up stock markets all over the world, is ending, with the Federal Reserve looking to shrink its balance sheet.

The Markets Want Your Money. Don't Give It to Them.(Smart Contrarian)

Feb 9, 2018

MFs are having a gala time taking money from over-eager investors and funneling it into equities. Smart investors, though, know better than to do that.

The Big Gamble(The Honest Truth)

Feb 15, 2018

Once you accept the fact that elections are round the corner and that this budget is geared to reach a 40% target, everything makes sense.

Rising Dominance of Mutual Funds(Chart Of The Day)

Feb 8, 2018

Domestic money flow into Indian equities surpassed foreign fund flows in the recent years. But will it continue in volatile market?

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Feb 21, 2018 (Close)

MARKET STATS