Risk

After the recent Rok debacle I thought it might be a good time to look at the risk in my portfolio.  It may be shutting the stable door after the horse has bolted but, at the risk of stretching a metaphor too far, there are still 20 other horses in my stables and some of them are looking skittish.

I'm going to split my portfolio into a few broad areas.  From least risky upwards:

1. Safe.  No cause for concern
2. Solid.  Some concerns, but nothing major.
3. Speculative.  Known problems, but they should pull through.
4. Risky.  Acute problems - real risk of wipeout.

1.  Safe (36% of portfolio)

First into this category goes Berkshire Hathaway.  A book value of $150bn gives me a lot of confidence (even if $80bn of that is goodwill and "other").

NWBD is next on the list.  For this to suffer losses you would first have to assume that NatWest has gone bankrupt.  Then you would have to assume that its owner, RBS, would refuse to rescue it - i.e. either its losses are catastrophic, or RBS itself was bankrupt.  Given that didn't happen in 2008-2009, I'm happy that it is unlikely to happen in the future either.

LLPC follows close behind.  Although it is more exposed than NWBD (its dividends are currently suspended), it escaped the recent crisis with the loss of only 2 years' dividends - in the scheme of things that's peanuts.

Tesco makes it into this category thanks to its strong balance sheet (a fair amount of debt, but mostly long-term funding, backed with an extensive property portfolio), consistently strong profit margins, international diversification and a business that should be around for the long-run.

2.  Solid (31%)

British American Tobacco and Diageo make it into the top-end of this category.  They don't quite qualify for my top rank: BATS because worldwide tobacco use will eventually decline, and Diageo because of its heavy debt load.  Apart from those concerns, these are strong businesses with healthy profit margins, strong brands, loyal customers and international diversification.

I'm going to bundle in two of my 3 ETFs here: IDVY and IAPD.  These are both focused on high-yield shares, which I think on the whole gives you a pretty solid set of companies.  

GlaxoSmithKline looks, on the face of it, like a pretty healthy business, with massive margins, a decent balance sheet and good international diversification.  But they face reduced healthcare spending in developed countries, plus expiring patents and generic competition.

National Grid just about makes it into this category because of its reliable, regulated income stream.  My concern is that it has an enormous heap of debt, and I don't really understand the risks it could face.  

3.  Speculative (27%)

IEEM is definitely an ETF that fits better into the speculative category.  It invests primarily in large cap shares in emerging markets, and has historically been pretty volatile.

Greene King comes in at the solid end of my speculative category.  It has a lot of debt, and faces long-term headwinds in terms of fewer customers and higher taxes on alcohol sold in pubs.  But it makes a decent profit,  its debt is funded a long way out, and most of its pubs are transitioning well from "wet-led" to family-friendly pubs serving food.

BP has one big problem: the legal/political consequences of the GoM blowout.  Beyond that, it's a very solid, profitable business, with a strong balance sheet.

De La Rue is also a great business facing one problem - the loss of reputation/business from this year's quality issues.  Excluding that, it is consistently profitable, with good margins, a solid balance sheet, and is a world leader in their field.

I have a clutch of software companies that I think fall roughly here in my list: QDG, MXM and BDI.  QDG is not hugely profitable but has a solid balance sheet.  MXM has a very strong cashflow but quite a bit of debt.  BDI has a great product but is not massively profitable.

4.  Risky (6%)

Game Group comes at the more solid end of my risky category, but faces a number of issues: very low margins, a squeeze from supermarkets cherry-picking the most popular products, and online competition from the likes of Amazon and play.com.  Their balance sheet is not fantastic, so one bad Christmas could get them into rather a lot of trouble.

Carpathian is a business that will definitely be worthless in a year or so.  The only question is how much cash shareholders can extract in the meantime.  If they manage to sell their assets for the prices they expect, then shareholders should do OK - but a further deterioration in Eastern European property could rapidly see them become worthless.

Southern Cross comes right at the bottom of my list.  Tiny margins, declining occupancy, consistent unprofitability, hugely expensive rental contracts with guaranteed annual increases and reduced spending by local authorities all conspire to make this a share only for the brave.

Rok
So where would I have put Rok in my list if I'd written it a few weeks ago?  I think it would have gone in the Risky category, probably just above SCHE.  But that's why it was trading on a P/E ratio of less than 3.