I think that risk is one of the most misunderstood things about investing. That?s because many investors use a stock?s price movement ? its volatility, in other words ? to measure risk. But, that may not make much sense.
Warren Buffett, one of the best investors in the world today, once said that ?If a business does well, the stock eventually follows.? What is worth noting in Buffett?s words is the idea that over the long-term, a stock?s price is tethered to the performance of its business. As such, a focus on a stock?s business fundamentals as a way to gauge…
I think that risk is one of the most misunderstood things about investing. That’s because many investors use a stock’s price movement – its volatility, in other words – to measure risk. But, that may not make much sense.
Warren Buffett, one of the best investors in the world today, once said that “If a business does well, the stock eventually follows.” What is worth noting in Buffett’s words is the idea that over the long-term, a stock’s price is tethered to the performance of its business. As such, a focus on a stock’s business fundamentals as a way to gauge its risk seems more logical in my view as compared to a focus on its price-volatility.
With these in mind, just how risky is airline caterer and airport terminal services provider SATS Ltd (SGX: S58) as an investment? There are other important aspects of the firm’s business to look at, but in here, let’s turn our attention to just two areas:
1. Balance sheet risk
Debt can make a company fragile. When a company with a heavy debt load has trouble servicing or repaying its loans, its shareholders may have to face painful outcomes such as dilution, an elimination of dividends by the firm, involuntary sales of assets by the company, and in the worst-case scenario, the firm’s bankruptcy.
There are good reasons why Walter Schloss, an investor with a fantastic long-term investing track record, once said, “I like to look at the balance sheet and I don’t like debt because it can really get a company into trouble.”
A strong balance – one that is flush with cash and has little debt – has the opposite effect. It gives a company higher odds of emerging from tough times unscathed and can even help a company go on the offensive during downturns just when financially weaker competitors have to batten down their hatches in order to simply survive.
For SATS, its balance sheet looks to be in tip-top condition. As of 31 December 2015, it has S$417 million in cash and just S$109 million in total debt.
2. Customer concentration risk
It’s easy for a company to run into deep trouble if it depends on just a handful of customers for business. Just think of what can happen to the company if just one of its customers collapses or decides to walk away?
That’s a risk that SATS is bearing at the moment. In the company’s annual report for its fiscal year ended 31 March 2015 (fiscal 2015), it was stated that “[R]evenue from one major customer amounted to [S]$743 million.” SATS had earned total revenue of S$1.75 billion that year, meaning to say that the major customer had accounted for over 40% of the company’s business.
Having a high level of customer concentration need not necessarily be a bad thing. But, it’s still a risk that investors may want to note and keep an eye on.
A Fool’s take
In sum, SATS appears to be a company with a low level of balance sheet risk but high customer concentration risk. Regarding the earlier question on just how risky SATS is as an investment, what we’ve seen about the company in here – while insightful and important – is not sufficient for a firm conclusion to be made. As I had written earlier, there are other aspects of SATS’s business fundamentals that needs to be considered as well.
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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 doesn't own shares in any companies mentioned.