One Important Lesson About Risk For Investors

On 6 October 2014, U.S.A.-based sapphire glass manufacturer GT Advanced Technologies filed for bankruptcy protection. As a result, common shareholders of the company got largely wiped out in a single day. The manufacturer made headlines late last year when it secured a supply agreement with Apple Inc. to supply sapphire glass for its upcoming products.

On the day of bankruptcy, it became clear that GT Advanced Technologies had become too dependent on its supply agreement with Apple to secure the loans that it needed to build its new Arizona plant. The company had racked up $294 million in debt by 30 June 2014. The problem arose when non-Apple creditors started calling back their loans and GT Advanced Technologies could not fulfil their wishes. Filing for bankruptcy was the result.

All said and done, is there a lesson to learn here about risks?

Concentration risk

Beyond the obvious high debt load, one of the key issues was that GT Advanced Technologies had become too dependent on one customer (Apple) for its source of revenue. In this case, the high customer concentration might have turned the nature of the company’s risk into a binary one. This would be akin to basing the survival of a company on a coin flip. With a risk profile like that, it can leave very little room for a company to react when the coin flip goes against it.

With the above, it thus pays to note high concentrations of risk at the local front as well. For instance,  diamond systems manufacturer Sarine Technologies Ltd (SGX: U77) derived 76.5% of its revenue from India in 2013. This could leave it vulnerable to changes in political climate in that country.

In another example, shares of electronic manufacturing services provider Valuetronics Holdings Limited (SGX: BN2) fell by 15.8% on 14 October 2014 when its main customer decided to restructure its LED lighting business. According to a research report from Maybank, 40% of Valuetronics’ revenue came from that main customer.

Not all risk is made equal

Now, although Sarine and Valuetronics both have concentration-risk, it’s not to say any of them will “do a GT Advanced Technologies,” and spring a surprise on us one day. To be sure, this also doesn’t signal that individual investors should immediately avoid the duo.

After all, all companies contain risks that we have to manage as investors. Identifying areas with high concentrations – whether it is by product, country, technology, or customers – is the first step in helping Foolish investors be more aware of possible binary-type risks in our companies.

Foolish take away

The key here is really to first recognise the presence of any concentration risk, and then understand the degree of that risk, so that we might have the chance to place an appropriate margin of safety to cater for it. And, if any of the identified-risks are too high for your own taste, always feel free to chuck that share into the “too hard” pile.

If Foolish investors can start by recognizing the types of risks in our investments, then we might begin to better allocate our money more wisely among different companies according to their different risk profiles. By committing less errors, Foolish investors might then increase the odds of finding investing success. For more investing tips and tricks, sign up for a FREE subscription to The Motley Fool’s weekly investing newsletter,Take Stock SingaporeIt will teach you how you can GROW your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.