Risk is one of the most misunderstood things about investing in my view. Many investors use the movement of a stock?s price ? in other words, its volatility ? as a way to measure risk. But, that may be faulty thinking.
?Using volatility as a measure of risk is nuts,? Charlie Munger once said. Munger?s views on investing may be well worth heeding, considering he had a stellar track record as a fund manager in the 1960s and 1970s and is a long-time sidekick of billionaire investor Warren Buffett.
Munger went on to propose a better way to view risk….
Risk is one of the most misunderstood things about investing in my view. Many investors use the movement of a stock’s price – in other words, its volatility – as a way to measure risk. But, that may be faulty thinking.
“Using volatility as a measure of risk is nuts,” Charlie Munger once said. Munger’s views on investing may be well worth heeding, considering he had a stellar track record as a fund manager in the 1960s and 1970s and is a long-time sidekick of billionaire investor Warren Buffett.
Munger went on to propose a better way to view risk. “Risk to us is (1) the risk of permanent loss of capital, or (2) the risk of inadequate return,” he added.
For investors in the stock market, a big reason for the occurrence of a permeant loss (or lower than expected return) is a lousy performance (or worse than expected performance) from a stock’s underlying business over the long-term. And, that’s because a stock’s business is often the main driver of its price in the long run.
With all the above in mind, just how risky is healthcare services provider Raffles Medical Group Ltd (SGX: R01) as an investment?
The company has been a massive long-term winner with the price of its shares having soared by a total of 556% over the past 10 years; over the same period, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has gained only 15%. But, that is then and this is now. It’d be useful for investors to run a fresh pair of eyes over the company.
There are a number of ways to measure Raffles Medical’s riskiness, but the following two are important things that I’m looking at:
1. Balance sheet risk
A company can easily inflict pain on its shareholders if it has excessive levels of debt on its balance sheet.
In tough economic environments, a company that has been borrowing rampantly may find it hard to service or repay its loans. In such an event, shareholders may then have to face bad consequences such as a dilution of their stakes in the firm, involuntary asset sales by the company, a complete elimination of dividends, or in the worst-case scenario, bankruptcy.
On the other hand, a strong balance sheet – one that is flush with cash and with little debt – gives a company a higher chance of surviving rough times unscathed.
That’s not all. A strong balance sheet may even allow a company to go on the offensive during a downturn and gain competitive advantages over financially weaker competitors that have to batten down the hatches when things turn south.
In the case of Raffles Medical, its balance sheet appears to be in a healthy state. As of 31 December 2015, the company had S$86 million in cash and just S$32 million in total debt.
2. Customer concentration risk
If a company has just a handful of customers, its business can run into deep trouble if one or a few of them collapse or decide to walk away.
GT Advanced Technologies, a U.S.-based maker of sapphire glass products, had to learn this the hard way. The company had to file for bankruptcy back in late 2014 when its product failed to meet the specifications of its customer Apple Inc. At that time, GT Advanced Technologies had likely depended on Apple for the majority of its revenue.
For Raffles Medical, I think it’s safe to assume that the company has low customer concentration risk. In 2013, the healthcare outfit had served a total of 4,470 patients. In the same year, the company’s corporate client count also came in at 6,500. With thousands of customers in each year, it’s unlikely that Raffles Medical would depend on only a handful of them for a big chunk of its revenue.
A Fool’s take
In summary, Raffles Medical has low balance sheet as well as customer concentration risks. But, this does not mean that Raffles Medical will necessarily be a good investment going forward. Research on other aspects of the company – such as its growth opportunities – will also be needed before any investing decision can be reached.
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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 writer Chong Ser Jing owns shares in Raffles Medical Group.