Conglomerates Sector by Better Trades

Consisting mainly of several distinctive and often unrelated businesses, Conglomerates are the result from multiple companies converging and combining their business practices under one entity’s control.

Often referred to as multi-industry companies the earliest known conglomerate dates back to 1602 in the Netherlands. It was here that parliament within the country granted a monopoly to the Dutch East India Company (VOC - Vereenigde Oost-Indische Compagnie, in Dutch), which allowed them to carry out all colonial activities dealing with trade, most notably spices, in Asia.

The Dutch East India Co. was the first known multinational company and was the first company that issued stock. The company was so large and powerful that they possessed quasi-governmental authority, the power to wage war and negotiate treaties, along with the authority to press coins and establish new colonies.

The VOC was a viable and profitable company heading into the 19th century. Up until that time, the company paid, on average, an 18% dividend annually. The company was officially dismantled in 1800, and was later referred to as Vergaan Onder Corruptie, which translates as “Perished By Corruption”.

Further along in history, conglomerates became increasingly popular within the U.S. in the early 1960s. With the markets gyrating between gains and losses throughout the decade, along with interest rates near all-time lows, companies were able to swoop in and snatch up floundering companies with leveraged buyouts and even deflated values.

The key catalyst to the purchasing of devalued companies during this time was whether the target company had profits greater than the interest on the loans to purchase the company, thus representing a positive return on their investment (ROI).

The disillusion of these mega-companies was that in the beginning, investors were drawn to powerful and aggressive companies that appeared unstoppable in their business practices. Once interest rates begin to increase, due to an increase in inflation, investors were shocked to see that these conglomerates began to lose money, and the companies that they had bought up previously, were not posting any higher profits than they had before their purchase.

By the end of the 1960s and into the greater part of the 1970s, conglomerates were dismissed as investors looked elsewhere. Shares of the mega-companies were quickly reduced in price and subsequently sold-off. After these drastic measures, conglomerates reverted to focusing on their core competencies in order to remain in business.

In the modern business environment, conglomerates have their hands in many facets of today’s economy. With companies such as General Electric (GE), branching out into the financing and financial service fields, and Berkshire Hathaway (BRK.A) investing in the manufacturing and service industries, these highly successful conglomerates are a far cry from the typical conglomerates formed back in the 1960s.

Within the U.S., several conglomerates prosper and thrive today. These would include, 3M Co. (MMM), News Corporation (NWS), Teledyne Technologies (TDY), Dell (DELL), Walt Disney (DIS), Time Warner (TWX), Honeywell International (HON), General Motors (GM), Hewlett-Packard (HPQ), Johnson & Johnson (JNJ), Proctor & Gamble (PG), Microsoft (MSFT), Raytheon Co. (RTN) and ITT Corporation (ITT).

However, these companies do have their shortfalls, just like any other company out there. When a mega-company loses their focus on current business practices, or has the inability of managing unrelated businesses under their control, it is at this time that investors and analysts alike begin to penalize the conglomerates, thus pushing its shares lower in price within the markets.

This disconcertion of the company’s overall operation is known as Conglomerate Discount. This undervaluing comes from the valuation of the sum-of-all-parts within the company and is the main reason why conglomerates spin-off or separate from current subsidiaries or holding that the company currently controls.

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