We recently compiled a list of the 8 Best Conglomerate Stocks to Buy Now. In this article, we are going to take a look at where Compass Diversified (NYSE:CODI) stands against the other conglomerate stocks.
What are conglomerate stocks? These stocks are the ones that have their ownerships in diverse businesses, spanning different sectors like finance, energy, technology, healthcare, etc. To be precise, a conglomerate is a business model where many companies are collected into a single large corporation that is owned by the parent company.
A conglomerate can consist of many businesses in the same industry or from different industries to diversify business and navigate risks. Some conglomerates tend to own a series of companies that make up the entire labor and supply chain for a single end product.
In a conglomerate, a parent company has the controlling stakes of all the smaller and unrelated businesses that operate independently. At times, conglomeration gets enacted by holding companies specializing in M&As. These companies are formed specifically to acquire smaller companies and collect business interests.
Investing in Conglomerate Stocks
There are several benefits of investing in conglomerates, some of which include diversification into several sectors, stability in revenues, synergistic opportunities, and many more. Conglomerates tend to provide greater stability and resilience at the time of market fluctuations as compared to pure-play companies.
Conglomerates have internal capital markets. This means that if one business of the conglomerate performs poorly, its loss can be offset by the other businesses performing relatively better. These businesses benefit by establishing synergies as the costs of operating a series of businesses can be reduced via consolidation. Conglomerates are capable of moving significant sums of money from businesses having limited opportunities for incremental investment to other areas possessing greater potential. These businesses have the potential to scale far larger in size as compared to the businesses constrained by the limited potential of that particular industry in which they are present.
Therefore, venturing into different industries can result in synergistic benefits, which can lead to significant cost savings along with improved cost efficiency. When a series of businesses in a conglomerate combine their resources, the conglomerate CEO can negotiate better deals with suppliers and manage procurement costs. This will ultimately lead to the optimization of production processes. Conglomerates can leverage a diverse portfolio of businesses, leading to cross-selling and cross-promotion opportunities. Through the promotion of complementary products, conglomerates can drive revenue growth.
2024 has been quite volatile for the broader market as a result of sticky inflation, high interest rates, and recession fears. Investing in conglomerates might help investors steer through these uncertain times. S&P 500 Industrial Conglomerates Sub-Industry Index saw a return of over ~35% over the past year, while the broader index (Dow Jones Industrial Average) went up by ~12%.
While investing in conglomerates has benefited investors most of the time, some may find these investments challenging. There can be a loss of efficiency, including a divergence from the core businesses. Moreover, the resources that get divided over numerous businesses might not be synergistic. There can be a lack of transparency in conglomerates, impacting their brand name and market share.
For investors, it is of utmost importance to know the company’s true picture. Only then will an investor be able to generate strong and stable returns. Conglomerate CEOs can sometimes resort to dubious accounting methods to show inflated EPS numbers. Warren Buffett exposed this trend in a letter and explained how conglomerate CEOs, in the late 1960s, used to drive their conglomerate’s stock to 20 times earnings only to issue shares at a higher price and then deploy the proceeds to buy out other cheaper companies. At some point, a conglomerate becomes a collection of poor underlying businesses, with little or no growth prospects.
Later on, through the application of different accounting methods, they show increased per-share earnings. This process ultimately led to the redistribution of wealth, rather than the creation of wealth.
Wealth creation comes from investing in stable and sound businesses, having efficient accounting practices, and strong management. Therefore, investors should be wary of bad management and financial shenanigans while investing in conglomerate businesses.
That being said, if the conglomerate form is used effectively and transparently, it can act as an ideal structure for creating generational wealth.
Our Methodology:
We screened for conglomerate stocks on the Finviz stock screener. We compiled an initial list of 15 large conglomerates by market cap and checked their average price targets. We then selected and ranked the 8 stocks that analysts saw the most upside to, as of 6th August 2024.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
An overview of a manufacturing plant, representing the production of consumer products from the company.
Compass Diversified (NYSE:CODI)
Average Upside Potential: 39.83%
Compass Diversified (NYSE:CODI) owns and manages a diverse set of highly defensible, middle-market businesses throughout industrial, branded consumer, and healthcare sectors. The company offers both debt and equity capital for its subsidiaries, contributing to financial and operating flexibility.
The company released its consolidated operating results for the 3 months ended March 31, 2024, with net sales rising 8% as compared to pcp to $524.3 million. This was aided by 61% rise in Lugano net sales and acquisition of The Honey Pot Co. Net income of the company came in at $5.8 million against $109.6 million against pcp. This difference was due to $98.0 million gain on sale of Advanced Circuits in February 2023.
Recently, Compass Diversified (NYSE:CODI) divested its Crosman air gun division. This divestment further strengths the focus of Compass Diversified (NYSE:CODI) on managing innovative and disruptive companies. The proceeds from this transaction will be used for reducing debt and for general corporate purposes.
The stock was held by 7 hedge funds in 1Q 2024, with total stakes worth $24.4 million.
Overall CODI ranks 7th on our list of the best conglomerate stocks to buy. You can visit 8 Best Conglomerate Stocks to Buy Now to see the other conglomerate stocks that are on hedge funds’ radar. While we acknowledge the potential of CODI as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than CODI but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.