Investors are often surprised when a company reports some difficulty that sends sales, profits — and the share price — slumping.
Just think of the recent fall in ASOS shares. The share price of the online retailer is down over 50% in three months. Clearly, investors didn’t see the deterioration in its margins coming.
Often a share price decline is perfectly rational. Perhaps a threat has turned out to be bigger than previously supposed, or a potential risk has become a business reality.
But too often investors seem truly surprised by whatever difficulty has come to roost — even one repeatedly flagged up in advance.
This has consequences for all of us looking to put our money into good companies at sensible prices. Excessive complacency can send prices too high, given the risks facing the business.
Again, just ask those ASOS shareholders.
Risky business
It pays to make sure you are acquainted all the risks facing any company you invest in. This way, you’re on the informed side of the trade should your fellow investors turn into headless chickens!
But how do you go about this? Few of us can do a full-blown risk assessment of every new investing idea.
Happily, this isn’t required to get a feel for challenges a company faces. Big companies are required to list the principle risks they face in their annual report to shareholders. Simply perusing this list puts you ahead of most private investors.
Let’s consider Vodafone (LSE: VOD) (NASDAQ: VOD.US) as an example.
Vodafone has just released its 2014 Annual Report. Download it via Vodafone’s investor relations website and turn to page 196, and you’ll find 11 key risks detailed over five pages, as well as supplementary information on a range of general business risks.
A few of the risks are too vague to tell you much about Vodafone. Most large companies face the risk of writedowns on underperforming assets, for example, and all multinationals must deal with currency risks.
But there several risks highlighted by Vodafone that could make the ‘shock horror’ newspaper headlines of the future:
Risk 5: “Our existing service offerings could become disadvantaged as compared to those offered by converged competitors or other technology providers (“over the top” — OTT competitors).”
Say what? Okay, I never claimed it would be trivial to parse the legalese employed by companies to discuss their risks! Luckily, Vodafone’s Annual Report explains exactly what this risk entails.
There are actually two issues here. Firstly, Vodafone faces competition from providers who can sell bundled offerings across their infrastructure — some combination of fixed line, broadband, public Wi-Fi, TV and mobile — that Vodafone either cannot wholly compete with — because it doesn’t have a TV offering, say — or that it cannot match on price, especially if the bundlers subsidise their mobile component.
In addition, new threats to traditional communications can ding the earnings potential Vodafone has spent billions amassing over the decades. Think Facebook messaging displacing the revenues from text messages.
Risk 7: “Our business may be impacted by actual or perceived health risks associated with the transmission of radio waves from mobile telephones, transmitters and associated equipment.”
It might surprise you to see this risk in the Vodafone annual report — it certainly did me. This is an annual report, not a tabloid scare story!
Given my understanding of the science and medical research to-date, I think Vodafone is more covering its, erm, assets here, rather than flagging up a major potential worry. The company itself states there is “no evidence that convinces experts”, and it also points out that anything that hit it will hurt its competitors, too.
Nevertheless, a shareholder cannot say they weren’t warned if long-term mobile phone addicts grow a third ear…
Risk 10: “We may not satisfactorily resolve major tax disputes.”
Vodafone talks about its operations around the world and the occasional disputes that crop up, but it soon gets down to brass tacks: The major tax row underway in India, where the Indian government and the country’s Supreme Court appear to be at loggerheads over retrospective tax legislation applied to Vodafone.
Conflicts of this type aren’t just bad because they could cost Vodafone money. They might also damage political and regulatory relationships, which can only be negative for a big infrastructure player like Vodafone.
Read the whole risk section and you shouldn’t be surprised to see the Indian tax dispute flare up again, or to see a similar conflict arise in another emerging country in future.
