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


ssukumarGB-PL-BASIC
OGCAMGBad Investments
lane1020Quality/Interntional
rael2222A3
mgh_38General Screens
mgh_38Oil_Gas_Chems
mgh_38Forbes Ben Graham
rael2222A2
rael2222aristocratic
rael2222the best 30 anni
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