We are out. Last week the Forager Australian Shares Fund sold its last remaining shares of online lottery ticket reseller Jumbo (JIN). Our margin of safety dwindled in the past year and it was time to exit this very successful investment.
It would have been an ok result had we just held the original shares bought at just north of $2 each. Some healthy dividends and doubling your money over five years is not to be sneezed at. But most of our money on Jumbo was made, unsurprisingly, by buying when others were most fearful. We added a large parcel at $0.87 a share, when almost half the market capitalisation was covered by cash in the bank. And what exactly were they fearful about?
A sole supplier
Well, apart from a loss making German foray, Jumbo has one major supplier – Tatts Group. Tatts owns all of the legitimate lotteries in Australia apart from WA, which is still run by the WA government. Without Tatts, Jumbo’s business would not exist. When Jumbo was trading under $1 in 2015, the risk of Tatts cutting Jumbo off was all investors could think of.
That risk was always there, but it’s all about likelihood. The likelihood of a poor outcome often changes gradually over time. But markets are not so kind. The perception of a risk changes dramatically. Big changes in stock prices result. When stocks are up, risks like this start getting ignored, even if their likelihood hadn’t changed. When prices are down, they become a focus, despite not being any more likely than before.
Tatts and Jumbo did do a short term deal, but now, at over $4.50 no one cares that in a few years Jumbo could end up without any tickets to sell. Despite now being a shareholder in Jumbo, the risk may well have increased since a government crackdown on common foe Lottoland.
Of course this isn’t the only time that a big risk has been overlooked when things were going well.
Ignored risks that do come to pass
Vita Group (VTG) is another business that always had a big risk hanging over it. Except this one ended up actually causing the company a whole lot of trouble. Throughout Vita’s four-year journey from $0.25 to over $5 few would have denied that Vita was dependent on Telstra (TLS) for its business – being mostly running Telstra stores under franchise. At the peak though, attention was firmly on continuing growth of sales from existing stores, broadening out into Telstra’s business centres and after-tax profit growth of 83%. Little mention of the Telstra risk. And then Telstra did it. They renegotiated the terms under which Vita operated its stores. The stock price went to $1.
And if you would have asked investors in alternative fund manager Blue Sky (BLA) how much visibility they had over the valuation of the business’s private equity investments they may have said “not much, but it doesn’t really matter”. And it didn’t. For a while. The company’s March equity raising presentation trumpeted funds under management up 44% and profit after tax up 59%. The stock was up six times in three years. Then came Glaucus, pointing out that very risk (and a bunch more). Blue Sky fell more than 80%. Confidence, key to funds management , was gone.
Getting paid for risk perception
In many of the stocks we buy, big risks are easy to find. Thorn’s consumer finance business will be squashed under regulatory pressure. Offshore oil and gas spending won’t return to help MMA Offshore with its heavy debt load. NZME’s profits are in terminal decline as traditional media spending dies. All of this can happen. But having those risks in sharp focus means we are more likely to get paid to bear them.
Instead of avoiding risk, we’ve made a habit of looking for situations where the perceived likelihood of a risk is higher than the real probability. You can look very stupid when one of those “obvious” risks comes to pass. You can make a lot of money when they don’t.
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Alex is a Senior Analyst at Forager Funds Management, responsible for researching stocks for the Forager Australian Shares Fund.