For investors, the benefits of diversification are pretty obvious. Certainly, an individual may be a superb investor and buy shares in the best company with the strongest balance sheet, highest growth prospects and best educated management team around. However, he/she can still make a loss because of external factors that cause the financial performance of the company in question to disappoint. Therefore, diversifying among a number of high quality companies makes sense since it reduces company-specific risk.
The benefits of diversification, though, are not limited to investing. For example, Wesfarmers Ltd (ASX: WES) is much more than just a supermarket or retailer, it is a conglomerate with interests in coal production, chemicals, fertilisers, industrial and safety products, as well as the perhaps more familiar supermarkets and department stores. As a result, it offers more stability than the majority of retailers because its top and bottom lines are arguably less susceptible to weakness in consumer spending.
Because of this, the present challenges facing the supermarket and wider retail sector, in terms of consumer confidence and sales figures being disappointing, are not hurting Wesfarmers to a great extent. For example, the company is forecast to post a rise in its earnings of 6.8% per annum during the next two years – even though the Aussie economy's outlook is uncertain.
This is set to be a better performance than JB Hi-Fi Limited (ASX: JBH). It is a seller of home entertainment products and, while it sells a diverse range of goods (from TVs to cameras and musical instruments to printers) it appears to be more susceptible to the ups and downs of the business cycle than Wesfarmers. Therefore, its bottom line is expected to rise at a slower (but still respectable) 5.2% per annum during the next two years.
Due to its reduced resilience (and higher risk), JB Hi-Fi offers investors a wider margin of safety than Wesfarmers. For example, it trades on a price to sales (P/S) ratio of 0.5 (versus 0.72 for Wesfarmers), while its price to earnings (P/E) ratio is 26% below that of Wesfarmers at 13.1 versus 17.8. As such, a higher upward rerating could be on the cards for JB Hi-Fi than for Wesfarmers if the outlook for the Aussie retail sector improves over the medium term.
Meanwhile, both stocks remain top notch dividend plays, with their yields standing at 5.2% (Wesfarmers) and 5% (JB Hi-Fi). However, with dividends set to fall at the former by 1.8% per annum during the next two years and forecast to rise by 4.7% per annum during the same time period at the latter, the gap is set to narrow to just 10 basis points by financial year 2017.
As a result, both stocks appear to be worth buying at the present time, with Wesfarmers being a more stable, resilient and lower risk option which has a beta of just 0.64. In contrast, JB Hi-Fi is riskier but offers better value, more capital gain potential and, with a beta of 1.29, is likely to benefit more from a rise in the ASX.
However, looking ahead, and with there being a real threat of the consumer outlook getting worse before it gets better, Wesfarmers appears to be the preferred option if you are only able to buy one or the other.
