In investing, many tend to associate larger companies as “safer” investment. Is that really the case? Are companies with larger market capitalisation less risky than smaller companies? We look at the flaw in the assumption and why this belief can be extremely dangerous for investors.
A Low Risk Business Is not Always a Low Risk Investment
Companies operating in industries that can be considered as low risk such as consumers products such as tobacco or alcohol because they tend to have very stable growth and earnings. However, just being in a low risk business does not mean that the investment can be considered as low risk. Companies such as Guinness Anchor Bhd (GUIN: MK) saw its share price dropped from above RM21 per share to less than RM13 per share in the span of 2 years despite not suffering any major setback operationally. Its share price dropped more than 22.5% in this year alone. However, has its business suddenly transform to a more risky one? That is not the case. This just shows that even low risk business can faces times of high valuation or low valuation that has no relationship with its business.
Similarly, A Large Business Is Not Always A Low Risk Investment
Malaysia Airline System (MAS: MK) is the Malaysia’s largest airline for the past 50 years. Yet, its share price has been sliding for the most part of the last decade. For the past five years, it fell from about RM1.20 per share to the current RM0.22 per share. That is a drop of 82% in value for an investor. This shows that for a company facing a structural change in its industry model, it will affect both the large and small players.
Value In Action
I believe the takeaway of this little exercise should be the fact that investment should be made based on at least two very important analysis.
1) The economics of the business
We have shown that large companies facing a change in its economics will still be affected. Just think of Eastman Kodex, Blackberry and Malaysia Airlines.
Secondly, valuation is an important part of investment. Although we do not need to have a crystal-like calculation of the valuation of a company, we do have to understand the risk if we buy into an overvalued company.
More on that next time.
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