MYEG is a 30% CAGR compounder that has been growing for many years and given their return on capital runs at an average rate of 40-60%, it seems to indicate there is a moat, therefore it make sense for the market to give it a rich valuation of close to $9 billion even though the business only generate less than $200 mil of cash flow every year. Most investors are willing to pay up for the quality of the business, its earnings and future prospect. But things started to unravel last week when there is a high possibility that a change in government policy is likely to threaten the earning quality of MYEG, erasing more than $4 bil of market value in a matter of 2 days.
One thing that has always make me err on the sideline and prevent me from owning MYEG, apart from their rich valuation, is the risk that they derive most of their earnings from government contracts/projects. There is a supplier risk. And at the time, it seems hard to imagine a revenue source as 'stable' as coming from the government can become it's biggest risk & disadvantage overnight. It is like SKP Resources that rely on Dyson or Magni-tech that rely on Nike for the bulk of their earnings suddenly wake up one day and realise their biggest client has decided to stop doing business with them. The possibility is extremely small, but it is not zero. It is always hard to estimate this type of risk, the unknown-unknown, nonetheless, whether the chance is 0.01%, 3% or 5%, you have to take that into account - when that happens, what will happen?
In investing, it is normally not the frequency that matters, but the magnitude. In Soros words, "it's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong." MYEG is the kind of stock that has a high frequency of going up and likely to continue to do so until last week. The share price proves that. If you bought it at any point in time during the past 5 years, it shows that you've made the 'right' move. But that's not what matters. What matters is the magnitude, how much is it going to fall when you're 'wrong', it is the small probability high magnitude event, like changes in government policy, that decides whether you make or loss money. So there's a few things we can learn here.
When you think about earnings, it pays to know how they are generated and under what conditions that may change. Many things we assume to be an advantage, such as construction contracts, power plants concession, toll concession which we presume to be 'safe' can turn out to be a big disadvantage when things turn. Not to mention if you pay a high price in return for having that 'safety'. Long-term lease is one of the thing that is considered an 'advantage' for retailers since if you enter a long-term lease with the landlord, i.e the mall operator or land owner, you can get a more favourable/flexible lease term compare to short-term lease. The business earnings is less likely to get affected as well. But when Amazon started eating these retailers' lunch, long-term lease become their biggest fixed liability. These retailers saw their revenue decline, cash flow turning negative and the inability to meet their gigantic lease obligation forces them into bankruptcy.
This also raises the point that when you invest, focus on things that what can go wrong, the downside. We have a tendency to only look at the upside, how much money we stand to make when things are positive because that is the easiest (availability bias) for our imagination. We don't predict; we extrapolate. We extrapolate things will continue to move in the same direction, which is true for most of the time (high frequency) but as I mentioned it is the magnitude that is more important. Share price don't move because of earnings, they move because of surprises. Big hairy surprise like change in government policy is what move MYEG's price. Therefore, you have to consider alternative outcomes, the what-if scenarios when something bad happens. Kill your idea first before it kills you. That's the only way to avoid yourself from jumping out and ask 'what should I do now? should I hold or sell?" when things go wrong.
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