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Imagination Technologies plc’s woes highlight the importance of diversification

Image: Imagination Technologies: Fair use

This week, the Imagination Technologies (LSE: IMG) share price has fallen by 62%. The reason for this is the decision by Apple to move away from using the company’s intellectual property in its products. While this will not happen instantly, it will take place over the next 15 months-to-two years’ time.

Reliance on one company

While the loss of any customer is a significant problem for any business, the loss of Apple as a customer will hit Imagination extremely hard. It contributed over £60m in revenue in the most recent financial year. This works out as roughly half of the company’s total revenue. While the loss of half of total sales is clearly bad news, the deal with Apple was associated with minimal direct costs to Imagination. In other words, the vast majority of revenue from Apple was profit.

This reliance on one company for half of sales and the majority of profit is not uncommon in business. However, it is somewhat unusual for a major listed company to be so reliant on one entity for the bulk of its sales and profitability. Clearly, it is always easy to criticise in hindsight, but it now seems obvious that Imagination needed to have a more diversified business model. It was running a major risk of losing a key customer, which has now taken place.

Investor takeaway

Of course, diversification is not only crucial for companies, it is also of great importance for investors. While a portfolio of just a handful of stocks could record stunning capital gains and lead to high potential rewards, risks are also high. Even the most stable of companies with the best track records can endure challenging periods which lead to profit warnings. Therefore, the lesson from Imagination’s share price decline is to spread the risk among a number of different stocks.

Furthermore, buying shares in a variety of industries and geographies can also be worthwhile. This can help to reduce the overall risk of a portfolio. In addition, buying a range of different types of companies, such as growth, income and value stocks can protect against changes in investor sentiment over a period of time.

Looking ahead

While Imagination Technologies may be able to launch a legal defence of its patents or else agree a revised payment structure with Apple, the fact is that the company appears to be overly exposed to one business. As such, it does not seem to be an attractive buy given the opportunities which are available elsewhere at the present time.

Certainly, the company’s shares could mount a comeback, or they could fall further if a profit turns into a loss over the medium term. For Foolish investors, it proves why diversification is a required, rather than a desired, part of successful investing for the long term.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool UK owns shares of Imagination Technologies and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.