1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Mark Lin
Mark Lin
Articles (212) 

Why is Investing in Conglomerates Difficult?

November 23, 2012 | About:

Warren Buffet teaches us to invest in business that we understand and avoid those that we don't. A large part of the understanding is also affected by the structure of the company. Conglomerates with complex organizational structure and multiple subsidiaries, associates, joint ventures and different business or geographical segments pose a serious barrier to the level of understanding we hope to achieve.

I will talk about the three characteristics of conglomerates that makes investing in them difficult.

Firstly, conglomerates typically have multiple business units and operations located in different countries. This leads to the reporting of company performance through segment reporting. However, segment reporting is hardly perfect and lends itself to management manipulation. Management has complete discretion in choosing the reporting segments, as accounting rules are not specific in that aspect. For example, a company can choose to report its performance by individual countries of geographical regions. Companies can also use internal restructuring as a reason to combine or split up segments, making a historical comparison of segment performance more challenging. Also, the allocation of shared costs and assets to different segments is highly discretionary and can potentially be the true operating performance of a company.

Secondly, non-consolidated associates and joint ventures which are part and parcel of a complicated organizational structure for conglomerates allow management to hide debt off the books. This helps to improve the financial health metrics of a company. In addition, off-balance sheet operating assets which lie with non-consolidated associates and joint ventures, help to create an illusion of an asset-light business model and improved ROE and ROIC numbers.

Lastly, a conglomerate will typically have an active acquisition and divestiture strategy. It is very difficult to separate the effects of organic and acquired revenue for serial acquirers. On the other hand, divestitures offer companies opportunities to 'take a big bath' and 'dress up' their financial statements. Other peculiarities such as earnouts for acquisitions or partial divestment and conversion of subsidiary to associate creates further barriers to understanding.

About the author:

Mark Lin

Rating: 4.1/5 (7 votes)

Comments

Please leave your comment:


GuruFocus Mobile App


User Generated Screeners


pbarker46Hist Yield
nghassanFScore
dpostelMATERIALS AND INDUSTRIALS
DANGORDONREVENUS 7-29-16
gurufocusHigh quality
letsqueetScreener Test 1
DBrizanaapl & brk beater
kazuMomentam
DBrizanblank customized 29Jul2016
timschenkscreen 28 juli 2016

Select portfolio(s):

  • Loading...

Why you are interested?

Your selection and notes will be stored in your portfolio.

Login to add portfolio
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
FEEDBACK