Diversification Factors Reveal Two Potential Large Cap Winners

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 |  Includes: DD, DIS, IBM, INTC, JNJ, KO, MCD, MMM, PG
by: Michael Filighera

Moving the Market

Based on years of reviewing the Revere databases, we found that across all levels of capitalization, a company's diversification is a key factor in predicting its success. As a company grows larger and reaches capitalization levels of $25 billion or more, growth is significantly impacted by not only its diversification, but more specifically, by the ability of the company to compete in multiple sectors, the quality of its supply chain and the size of the geographic footprint of its customers.

Revere Outlook

Using Revere Research, we can assess market diversification by examining the companies in the Dow Jones Industrial Average (DJIA) and measuring their diversification. Specifically, we see three criteria as the basis to analyze these 30 companies: Sector Participation, Supply Chain and Geographic Revenue diversification.

Revere Research Reveals

Revere's research uncovered that the DJIA companies with greater sector participation outperformed those with less diversification. Also, we observed that companies with a healthy supply chain composed of top-performing suppliers posted more favorable results than those with less efficient supply chains. The extent of each company's geographic diversity also revealed that those with greater diversity had more potential for growth.

Furthermore, when we looked at the top three performing companies for each criterion, we found that these companies demonstrated longevity. We looked at the average returns of the top three companies, compared them to the DJIA in general for the most recent five-year period and found that most continue to outperform the DJIA.

PERCENTAGE OUTPERFORMANCE OF THE TOP 3 vs. DJIA - 5-YEAR TIME PERIOD
x
Top 3 Sector Diversified 1.26%
Top 3 Supply Chain Diversified 37.16%
Top 3 Geographic Diversified 52.93%
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Sector Participation Diversification Factor

We used the Revere Hierarchy to uncover the top three ranked companies among the DJIA 30 according to the breadth and depth of the products and services they sell. The top three most sector-diversified companies are 3M (NYSE:MMM), Proctor & Gamble (NYSE:PG) and Johnson & Johnson (NYSE:JNJ).

We then calculated the average returns on a one-, three- and five-year basis (as of 12/27/2010):

Name # of Sectors 1-Yr Return % 3-Yr Return % 5-Yr Return %
Johnson & Johnson (JNJ) 50 -4.53% -8.50% 1.90%
3M (MMM) 43 3.79% .50% 10.00%
Proctor & Gamble (PG) 22 5.22% -11.90% 10.80%
TOP 3 113 1.54% -12.5% 8.50%
DJIA ~13 9.55% -13.00% 6.30%
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The average returns for the top three most sector-diversified companies outperformed the DJIA by 1.5 percent and 2.20 percent in the past three- and five-year time periods.

Supply Chain Diversification Factor

The supply chain diversification factor seeks to evaluate how flexible and dependent a company is with its suppliers. If a company is very flexible and does not depend on any significant suppliers for its production inputs, it suggests it has good control over its costs and is unlikely to experience any production short fall when demand picks up.

Through Revere Relationships, we evaluated the supply chain of each of the DJIA 30 and looked at the breadth and depth of each. Based on this factor, the top three most supply chain-diversified companies are DuPont (NYSE:DD), Coca-cola (NYSE:KO), and The Walt Disney Company (NYSE:DIS).

Name # of Key Suppliers 1-Yr Return % 3-Yr Return % 5-Yr Return %
Coca-Cola (KO) 45 13.30% 4.40% 58.80%
Disney (DIS) 36 16.67% 15.60% 55.30%
DuPont (DD) 25 47.42% 11.80% 15.40%
TOP 3 106 25.79% 10.60% 43.16%
DJIA 2,159 9.55% -13.50% 6.30%
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The average returns for the top three companies outperformed the DJIA by 16 percent, 23 percent and 36 percent for the past one-, three- and five year periods (as of 12/27/2010)

In addition to our above findings, our research uncovered a strong correlation between the performance of companies and their suppliers. Top companies tend to have top-performing suppliers.

Geographic Revenue Diversification Factor

With Revere GeoRev, we measured the degree to which revenues from domestic and international markets are derived by each of the DJIA 30. As international trade and foreign investments flourish in many economies around the world, their consumer purchasing power has grown and remained strong even when the US faltered recently. Hence, companies that derived major percentages of their revenues from overseas stand a better chance of making up for any shortfall experienced in the US and are well positioned for future growth as these emerging markets continue to grow and/or when the US economy recovers. The top three most geographically diversified companies in the DJIA are Intel (NASDAQ:INTC), IBM (NYSE:IBM), and Mcdonald's (NYSE:MCD).

These companies have significantly outperformed the DJIA for the past five years (Returns as of 12/27/2010 - Int'l Sales % as of 12/26/2009):

Name % of Int'l Sales 1-Yr Return % 3-Yr Return % 5-Yr Return %
Intel Corp. (INTC) 85.0% 2.75% -22.30% -18.10%
McDonald's Corp. (MCD) 65.1% 19.94% 29.10% 124.10%
IBM (IBM) 64.3% 9.94% 32.60% 75.10%
Top 3 71.47% 10.87% 13.13% 60.36%
DJIA ~41.7% 9.55% -13.50% 6.30%
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CONCLUSION

Based on Revere's in-depth screening of the DJIA 30 companies through sector, supply chain, and geography diversification factors, we uncovered two companies that remain well-positioned for continued future growth and outperformance.

  • 3M Company (MMM) is sector diversified across four industries in 43 sectors that include: Consumer, Healthcare, Industrials & Materials, and Technology. Its supply chain is not dependent on any single supplier for production inputs and the company can flexibly source raw materials. 3M is geographically diversified, ranking sixth among the DJIA 30, with approximately 63% of revenues coming from overseas in 2009.
  • Dupont & Company (DD) is sector diversified across four industries in 13 sectors such as: Consumer, Technology, Business & Public Services and Industrials & Materials. It has multiple suppliers and is able to flexibly source raw materials. Approximately 59.5 percent of revenue was derived internationally in 2009.

Jeremy Zhou provided the original analysis and research for this piece as presented on September 22, 2010 by Revere Data CEO, Kevin O'Brien on CNBC's Closing Bell with Maria Bartiromo. Return % numbers are as of 12/27/2010.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.