Many well-known investors believe companies should focus on just one type of business. For example, if you are a retailer focus on retailing, don't diversify into mining. Often that would intuitively seem a sensible line of reasoning; however some companies have proven that there are benefits in diversification.
For example, imagine an insurance company that decided to go out and buy a chocolate manufacturer and retailer. Many commentators would deride such a move as dangerous and beyond the company's 'core' business. Imagine the insurer/chocolatier then went and bought a rail freight company – you can imagine the uproar from the financial community! Should someone put such businesses together under one conglomerate structure they would have something in common with one of the most famous examples of a conglomerate, Berkshire Hathaway (NYSE: BRK.A), run by billionaire investor Warren Buffett.
Buffett, over the years, has just kept adding businesses that he thinks represent good value for shareholders. These businesses now include sport shoes, reinsurance operations, electricity, trains, chocolate and numerous minority equity holdings as well. While theory may suggest otherwise, practice has proven that Buffett has created enormous shareholder value by "collecting" a diverse range of businesses.
Conglomerates like Berkshire Hathaway have long and colourful histories. Australia has two companies that stand out for their conglomerate structure and proud histories.
Wesfarmers (ASX: WES) originates from 1914 as a farmers co-operative based in Western Australia. Today it is one of the largest companies in Australia, with business operations spanning supermarkets, department stores, home improvement, office supplies, coal mining, insurance, chemicals, energy, fertiliser, and industrial and safety products.
Washington H. Soul Pattison's (ASX: SOL) history dates back to 1872 when a man by the name of Caleb Soul opened a pharmacy store on Pitt Street in Sydney. The company now has a portfolio of businesses that span pharmacy, building materials, natural resources, food technology, beverages, equity investments, media, telecommunications, merchant banking and funds management.
Strength through diversification
As can be seen in the chart below, since 1999 the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) has provided a return (before dividends) of nearly 61%. Over that time period Wesfarmers has provided shareholders with a 161.6% return, while Washington H. Soul Pattison has returned 320%.
Source: Google Finance
Foolish takeaway
An important attribute of conglomerates is that their diversified earnings base can help protect their ability to pay dividends. A review of the long dividend records of both Wesfarmers and Washington H. Soul Pattison is indeed impressive and highlights the appeal of this business model.
With both companies having significant exposure to coal mining operations, this segment of their respective businesses has been under particular pressure lately. Conglomerates, by their very nature, are likely to have at least one area of their business at any one time under some form of pressure. Pressure is of course what can provide opportunity for observant investors and is one reason to have these two quality firms on your watch list right now.
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
