The Rise and Fall of Conglomerate Investing

30 years ago conglomerates were all the rage in investing   Companies like General Electric (GE) and Berkshire Hathaway (BRK) were all the rage.    Instant diversification in a single stock, who could ask for more?  That was the sales pitch of the conglomerate. So what happened?

Conglomerate as a Diversified Choice

I can remember back in the 80s people would discuss General Electric as being a diversified play.  The thought was this conglomerate, invested in 20 or so different uncorrelated industries, provided one stop shop diversification.  In a world where index funds were still just starting to take hold, a conglomerate seemed to be the cheapest way to diversify across many businesses with a small investment.

Conglomerates Were Cheap To Invest In

How cheap?  Well in a world dominated by actively managed funds, a conglomerate lacked their expense ratios while still having the multi-company diversification everyone sought.    They just seemed like the perfect option for investors to spread their money around.

General Electric is Now Collapsing

Fast forward to today.     General Electric (GE) is a shadow of its former self.  Most analysts are now openly wondering if this once largest company in the world is on the brink of collapse.   GE, the company that has been in the DOW for 111 years and consistently provided dividend growth, has now been removed from that index. GE is now selling large pieces of their business to survive.  So obviously the conglomerate model failed to diversify enough if GE is potentially going down.

Why Is GE Collapsing: The Need for Management Diversification

Why is GE struggling?  Well if you read all the information on the situation it sounds like they became so complicated they took their eye off the ball.  Bad management, bad acquisitions, and lack of transparency led to their downfall.    Diversifying across industries hasn’t saved them, because what they really needed was diversification of management teams.  That I’d say is probably the first major problem with conglomerates.  When you diversify you don’t only want to diversify against industry business cycles.  You also want to diversify against poor management.   GE had no management diversification.

Conglomerates are Not a Means of Adequate Diversification

Now before I proceed I will point out, I have no crystal ball.  It’s possible GE could turn things around.  After all, another large conglomerate, IBM, was also once also on the verge of extinction.  And yet they turned it around by shifting focus.  GE could do that too, by righting their management and refocusing their business.   But even if they did, that would not invalidate the point of this post.  Conglomerates are not a means of adequate diversification.

The Conglomerate Berskshire Hathaway, An Exception?

There are some folks in Omaha that might have a bone to pick with my assertion.  Berkshire Hathaway (BRK) is almost like an institution.  Warren Buffet acquired this once textile mill company in the 60s and started adding businesses.  One of the first business’s added was insurance.  The float from the insurance businesses ultimately allowed Berkshire to acquire company after company.    Today Berkshire is one of the largest companies in the world.  They are also synonymous with conglomerates these days.  

Over much of the last 50 years, Berkshire has outperformed the market in terms of returns.  This in spite of most conglomerates historically selling at a discount to the sum of their holdings.  Berkshire has also, via Buffet, made some very fantastic bets over the years.  With Buffet’s now-famous value-based investing they have been in the right place to profit from events like the financial crisis in 2008 while avoiding the leverage that induced the downfall of GE and other large financial based companies.  It has not been uncommon over the last 10 years to hear people say if they could only buy one stock it would be Berkshire.  

Frankly, that affirmation makes me shudder a bit.    Don’t get me wrong, Warren Buffet has done a great job of growing his businesses.  He chose his investments wisely over the years and performance has been fantastic for those around from the start.    More recent performance has lagged the market slightly over the last five years.  A few weeks ago the stock took an even bigger nose-dive due to issues at Heinz.  But honestly, neither that recent performance nor the Heinz situation concerns me about Berkshire.

I have No Overt Concerns About Berkshire

In fact, as a single stock play of a larger portfolio, I have no concerns about Berkshire.  The stock may have some risk of a short term loss when Warren decides to move on.  It will also, like any other stock, continue to have the possibility of a single holding like Heinz hurting revenues.     Finally, it is very hard for a company it’s size to significantly move the needle on profits or revenues through investments.    While that probably means Berkshire is not the right choice for a play money account looking for a potential lottery winner, I have little concerns for it as a small stable piece of an overall portfolio.

Berkshire is Not a Full Diversification Play On Its Own

But, as a single stock play, that is where my positioning of Berkshire ends.    It is not a replacement for indexing of even indexing like, to be frank.  Buffet and his management target specific types of companies, primarily branded companies.  In this respect, his close corollary is a Hedge Fund or Actively Managed Mutual Fund.

He also, at least up until recently, has avoided certain sectors.  For example, he was decades late to investing in Tech, only recently adding Apple to his portfolio.  That’s all well and good, and might even be the right call for a given time period.  But that is again a type of specific management.    The management to target those type of businesses.    There is still no diversification in management because it’s a single company.  And thus philosophically it can never be as diverse as an index.

Management Changes Over Time

But what if you like Berkshire’s management?  That’s ok as well but remember management changes.  Warren may not be running the show in ten years.  His proteges may not either.  You never know.    That type of change happens all the time at companies.    Who knows if the replacements will be as good as what came before.

The Situation Changes

But, even if people don’t change the situation could.  The world, in fact, seems to be pushing away from brands to some extent.  The rise of non-branded stores like Aldi may portend a decline in the type of companies Berkshire has invested in as bread and butter for decades.    Who knows if their management will adapt to the changing business environment or continue to cling to the same type of investments that led to their rise.  

In a way, GE gives a cautionary tale there too.  Prior to 2007, GE’s most profitable division was finance.    They rode that train to the bottom of the financial crisis.  The leverage that business provided is a large part of their current undoing.    The management worked until it didn’t.

I do Not Own Conglomerates as a Diversification Play

I hope for the sake of so many that invest in Berkshire for large parts of their portfolio, that the doesn’t part is far in the future. (It is inevitable that someday in the future it won’t, nothing lasts forever.)  In any case, I won’t be buying Berkshire or any conglomerate as a diversified play.

Do you invest in conglomerates?      

Full Time Finance is for Educational Purposes Only. Any Investment you Make is Yours and Yours Alone. The author has in the past held stakes in both Berkshire and GE, however, he currently does not hold shares of either at this time. He does, however, hold shares of other conglomerates for various reasons, just not overall portfolio diversification.