‘One-Trick Ponies’ Take Fast Track Down Wall Street Focused Companies Outperform Mixtures

A few weeks ago, when Robert E. Allen, the chairman of AT&T, announced his plan to break the giant company into three pieces, he cited the stock market as one reason.

“The market value of AT&T was being buried,” he said. “Investors couldn’t understand the strategy of the combined companies.” And the market promptly agreed, sending AT&T’s stock skyward.

Yet the market also loved it when Michael D. Eisner, the chairman of the Walt Disney Co., made his move to buy Capital Cities/ ABC in a $19 billion deal that will expand Disney’s reach into more areas of the media and entertainment world.

It seems that Wall Street can’t make up its mind.

The reality is a little different. The focus sought by Allen is, in general, more highly valued by investors than the breadth Eisner is after, a new analysis shows.

The analysis, by Stern Stewart, a financial management advisory firm in New York, examined the 1,000 largest companies in market value. Companies less than five years old were excluded, as were financial services, real estate and electric utility companies.

The researchers found that the stock market does prefer “pure plays” - one-business companies - although the fact that these companies are usually small adds to their luster. The market is more skeptical about the value and future of big, complex, multibusiness corporations. And investors seem to believe a variation on Gresham’s Law: A bad business will drive out the value provided by good ones.

Stern Stewart used two key measures, which it had devised, to reach its conclusion. The first, “economic value added,” looks at how a company is doing in the books. It tracks whether a company is earning, on an operating basis and after taxes, more than its cost of capital.

In 1993, the most recent year examined, only the single-business companies on average made money, when profits were adjusted in this way.

Judging from the second indicator, a comparison of each company’s market value with all the capital that has been plowed into it over time, investors intuitively know that focus is better: they bid up stock prices of companies whose businesses are most concentrated.

On average, one-business companies created $2.27 in market value for every dollar invested in them, while companies with five or more businesses yielded $1.55. Put another way, the average market premium over book value was 127 percent for one-business companies, versus 55 percent for companies with five or more businesses.

The trend is so powerful that 79 focused businesses delivered more in market value than USG Corp., the top performer in the most diversified batch.

The analysis did not take into account how dividends might have improved shareholder returns.

But managers who could not even muster $1 of market value for every dollar entrusted to them are not doing much for shareholder wealth.

Individual companies with any number of businesses may shine, of course, - H&R Block, the tax preparer, is one example of a complex business that generated nearly $7 in market value in 1993 for every dollar of capital invested in it.

But the findings bolster the long-held suspicion that investors in general do better betting on focused companies.