A conglomerate discount, sometimes also called the diversification discount or the holding company discount, refers to a situation in which the value of stock of a conglomerate (i.e. a diversified group of companies) is lower than the sum of the different businesses. This means that the conglomerate is selling at a discount relative to its fundamental value.
Of course, it is also possible for the conglomerate’s stock to trade at a price higher than the sum of the parts. In that case, we refer to difference between the fundamental value and the stock market value as a conglomerate premium.
On this page we define the conglomerate discount, explain why it is not the result of diversification, and finally provide a conglomerate discount example.
Conglomerate discount definition
Is it really true that diversification destroys value, as the diversification discount suggests? This is strange of course, since the firms choose to diversify. So what may be explaining the diversification discount? Academic research has investigated the potential drivers of the diversification discount.
The dominant explanation, put forth by Campa and Kedia in 2002, is that there is self-selection taking place and that the discount is temporary. In particular, undiversified firms with low value decide to diversify, undiversified firms with high value don’t diversify. So the causality is not that diversification leads to a discount, but rather that undervalued firms decide to diversify. After a while, the discount among the diversified firms tends to disappear as the discount turns into a premium.
In other words, diversification does not destroy value. The firms were initially not conglomerates, but firms with low value. They then decided to turn themselves into conglomerates to diversify, but their low value (discount) hasn’t fully disappeared.
More recently, in 2004 Villalonga in a paper called “Diversification Discount or Premium? New Evidence from the Business Information Tracking Series” showed that the diversification discount is actually a data artifact. Instead, diversified companies tend to exhibit a robust premium.
Diversification discount example
Some examples of conglomerates are General Electric, Alphabet, and Berkshire Hathaway. While GE has been trading at a discount for a number of years, Berkshire Hathaway tends to trade at a premium. This shows that conglomerates don’t necessarily trade at a discount. Very often, the way the conglomerate is run matters more than the sum of the parts.
We discussed the diversification discount or premium. We noted that conglomerate discount research actually found that the discount is an artifact of the data. And even if the discount is there, there is a reverse causality. This is because undervalued companies tend to diversify and don’t become undervalued because of diversification.