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Stock Strategist Industry Reports

Death of the Diversified Discount

We highlight companies that have done an exceptional job investing free cash flow (and those that have not).

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The allure of investing in a diversified company is reasonably justified. These mature companies tend to grow faster than GDP, throw off lots of cash, and have survived long enough for investors to feel comfortable that they won't disappear during a recession. The challenge is that these companies plow a fair amount of capital back into their businesses, making it difficult to gauge the real success of these firms. The result is that while some companies get proper respect, a number of companies tend to trade at a discount to the sum of their parts.

While many accept the logic for the discount as an academic fact, a far more important lesson for investors lies in what the companies are actually doing with marginal capital and what return they earn on it. We can perform this analysis on firms in any industry, but the diversified space makes a poignant starting point, since these companies generally have strong cash flows, solid balance sheets, and heavy capital investing programs.

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Daniel Holland does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.