Risks, Gambling and Pints??

Investment is a game of uncertainty. It does not matter what you are investing in the only certainty is uncertainty.

Let's looking at some of uncertainties and risks that are underlying within different investment classes.

Cash - considered the safest asset class but it does not mean it is riskless. The risks here are that inflation will erode your purchasing power, if you have invested more than an insured amount (changes on your country) if your bank fails you can lose or if you choose to store it in a safe under the living room floor there is the possibility that you are the victim of theft.

Government Bonds - the major risk is that the government choices to default (or not pay) on it's debt. While this is generally considered to be an unlikely occurrence it is not unprecedented. Countries such as Greece, Russia, Mexico have had defaults that come to mind but it has also happened to Australia (back in 1931) and the US in the past. The other risk to bear in mind is interest rate and inflation risk similar to cash. For investors that want to hold to maturity the regular pricing fluctuations don't mean much but for those who are looking to trade these instruments in a short term manner, the pricing movements can be larger than popular thought would let you believe.

Real Estate - despite the common Australian belief that you can't lose with property it is possible to lose, primarily due to the leverage that most investors use with real estate. As many land lords are experiencing at the moment, if interest rates and holding costs rise to significantly above the mortgage payments then the asset may be forced to be sold rapidly to stop the bleeding of cash. Other than the risk mentioned previously, the other risks include property repairs or maintenance and the risk of no capital appreciation or even a loss. For example, in my home town property prices took nearly 15 years to recover from their pre GFC peak and 2012 Property Investor of the Year went bankrupt from their property investments. One last risk that I haven't mentioned is regarding the liquidity of property trusts, as the recent headlines continue to pile up, property isn't liquid and there is always the risk that your manager may not be liquid enough to meet your redemption requests.

I should clarify one thing, in the past I have been accused of being a property bear/hating property so my clients own more stocks. I invest, generally in a contrarian manner. Meaning I like to buy things that are cheap because they are unloved, I don't want to buy assets at all time highs, when money is at it's all time cheapest. I believe that property is a great investment when the following conditions are met:

1. The price is cheap
2. The yield is high
3. On the balance of probabilities I will achieve a reasonable rate of capital growth over the longer term.

Buying property on sub 2.5% yields, when the carry cost is in excess of 6% does not meet my criteria. I'm sure at some point I will turn into a massive property bull but it is not at this moment in time. But full disclosure, I thought Australian house prices were too expensive in 2019 and clearly I have been wrong for have a decade...

Stocks - stocks carry the most risk of all of these investment classes, even if leverage is not used. Companies are similar to organisms in nature. They are constantly changing, moving and like in the animal kingdom sometimes they die. This even happens to the biggest and strongest, the dinosaurs.

Ignoring the obvious risk of paying too much for a company or losing money in the day to day fluctuations of the market, the risks include:

1. Poor management - even the best companies like Apple and Microsoft have periods where management makes mistakes. The difference is that companies like Apple and Microsoft are able to recover from their failures but many companies are never able to. GE managed to go from one of the most respected companies to a perennial struggler based on poor management and poor capital allocation.
2. Poor capital allocation - this can come from a variety of factors including bad mergers and acquisitions, buying back too much stock, too much debt or investing heavily in products that fail. Or even take the recent example of Silicon Valley Bank and their issues.
3. They become obsolete. From horse and buggy manufacturers through to more modern examples like Nokia and Blackberry have gone from major notable institutions through to shells of their former selves.
4. Fraud - unfortunately frauds exist in financial markets more than optimists like me would like to believe. Arguably, the greatest example is the collapse of Enron which has been detailed extensively (side note, this is well worth a read).
5. Government intervention. This occurs in numerous ways, but the most common example for Australian investors involves mining companies based in Africa experiencing the government revoking mining licenses or as we have seen locally over the past few years government policies changing regarding climate change.

Governments love to change legislation, guidelines and laws for industry more than most businesses would like. In fact, I believe in the vast majority of industries reducing red tape and needless compliance would be a great outcome for the economy and the public. However, not all sectors should be lightly regulated. A prime example being gambling.

Gambling is a controversial sector to invest in. On a simple level it should be an appealing sector to invest in, it contains many of the characteristics that make a great investment.

Firstly, as the saying goes, the house always wins. There is no gambling gamble that the house does not either have a guaranteed win (the rake in a poker game) or a firm edge (i.e. roulette, baccarat, blackjack, pokies, etc). Mathematically, it is possible for gamblers to go on long winning streaks but over the course of millions of bets, the houses edge of 1-10% is mathematically impossible to beat.

Secondly, gambling is addictive. Industries that are involved in addictive products are generally good to consider investing in. For example, social media is no doubt addictive and in the case of Meta (formerly Facebook) have been good investments. However, gambling has a clear and obvious downside. Gamblers over time are expected to lose money. This can clearly impact upon finances, relationships and cause significant detriment to society.

Thirdly, gambling licenses are controlled at a government level. While it would take me minutes to open an online store selling shoes, it takes a long process to get a gambling license.

For complete transparency (and compliance), I should make it known that my clients and I hold Aristocrat Leisure, and a recent additional into Star Group.

The shares in ASX listed Endeavour Group were sold off more than 10% on Monday upon concerns that new pokie restrictions in Victoria will impact significantly across the groups earnings, as Victoria is their largest market for their pubs. Interestingly to note, the group actually is the third largest gaming operator in the country.

By introducing harm reduction measures, Victoria is trying to help their population deal with the issues that come with problem gambling. However, it must already be noted that many states in Australia including Queensland already have similar restrictions on how much can be put into a machine at one time, "slow" spin speeds and the like.

This appears to be another example of short term over-reaction by investors as the business still contains quality assets such as their Dan Murphy's brand, ALH pubs and BWS.

While history is no indicator of future success or outcomes, typically addictive and short term pleasurable vices such as smoking, drinking alcohol and gambling have shown to be more resilient in recessionary times than would be immediately assumed.

It reminds me of a time when I was at the pub (an ALH pub actually) with a mate I knew was doing it tough financially and yet was punting like there was no tomorrow on the ponies. I remember the conversation going something like this

Me: Bro stop punting, you are broke. You won't be able to pay rent on Monday

Him: I already can't. If I don't punt I definitely can't pay my bills but if I win I can.

Whilst this conversation probably shows the need for further gambling reform, it also shows that when in tough times people are willing to do ridiculous things for the chance to change their situation.

At the moment I have not updated my modelling into Endeavour Group and don't want to speculate on what the entity is actually worth but a significant movement like we have seen has this one on my watchlist to look over further on the weekend.

Have a cracking weekend,

Tyso

*Oh and as always, don't go investing based on these ramblings. If I'm giving you advice, it's in writing, addressed to you and has specific recommendations in it... you know the standard not financial advice warnings etc etc*