Peter Lynch, once of historys greatest investors, famously coined the worddiworsificationseveral decades ago.Diworsificationis, in simple terms, diversification gone wrong.
In many cases, companies that look to expand too fast, or expand outside their area of competence end updiworseifying rather than diversifying.
And it is easy to spot a company thats gone down this route.
Take Tesco for example. Over the past decade, the company has neglected its business here in theUK while trying to expand overseas.
Many of these overseas ventures have failed, and the core business has deteriorated. HSBC has made the same mistake, and its easy to spot the deteriorating performance of these companies by using one key metric.
Return on capital
Return on capital employed is a key metric used to measure business performance.ROCE shows how well a company is using both its equity and debt to generate a return. It other words, the metric shows how much profit the company is generating for every 1 invested in the business.
Investors tend to favour companies with stable and rising ROCE numbers as this shows that the business is using economies of scale to become steadily more productive. A falling ROCE implies that the enterprise is becoming inefficient, and returns are deteriorating.
Numbers reveal all
Tescos ROCE has been steadily declining over the past decade.Under the stewardship ofSir Terry Leahy, Tesco continually reported an annual ROCEof around 19%.
However, during the past five years ROCE has dropped steadily to 13%, then to 11% before coming to rest at 7.6%.
Like Tesco, HSBCsreturns have suffered due to the banks size. Rising legal costs and regulatory issues have also weighed on returns, despite drastic cost cutting measures.
Indeed, HSBC has closed77 businesses and slashed 50,000 jobs over the past few years,shavingaround $5bn from the banks cost base.
Nevertheless,over the same period the banks cost income ratio a closely watched measure of efficiency has remained stubbornly high at around 60%.HSBCs full-year 2014 cost income ratio was 67.3%.
HSBCs return on equity a key measure of bank profitability and a similar metric to ROCE has fallen steadily, from around10% to 7% over the past five years.
Moreover, HSBCs management has now given up on the banks target of generating an ROE of 12% to 15%. The target has been lowered tomore than 10 percent.
Tesco and HSBC have bothdiworsifiedand returns have suffered as a result. Still, there are other companies out there which have been able to maintain high, recurring returns on capital.
The five companies in question are defensive by nature and have all the qualities for you to buy and hold forever in your retirement portfolio.
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The Motley Fool has recommended shares in HSBC Holdings and owns shares in Tesco.