Reliable High Returns Require Low Risk

By: Henry F. Camp

 

How we are investing in our own operational ability to create a decisive competitive edge, capitalize on it in large enough markets without exhausting our resources and while undertaking less risk.

From Warren Buffett, a person I greatly admire, comes simple wisdom:

  … investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing power over his contemplated holding period.

I love Mr. Buffett’s definition of risk because it supports my affinity for having my cake and eating it too.  Risk is the reasoned probability of loss.

If our consulting business has taught us anything, it has taught us to mitigate risk.  To that end, we have created our own Strategy and Tactic trees that logically describe how to move a company’s supply chain from conventional to one that rarely runs out.  The logic is so tight that, with a disciplined sequential approach, we build and sustain for the client a decisive operational competitive edge in their marketplace.  From that position, the company simply uses their edge to gain share over time.  So, the S&T tree is our map for reliably and rapidly routing a conventional company to superior financial performance, with far less risk than the company accepted before.

Segue with me to IDEA’s new focus on buying companies, improving them and then selling them.  In the process of raising capital, I have run into an accepted bias: “The higher the return the higher the risk.”  Because our approach to improving supply chains results in a 10x reduction in shortages with less (not more) inventory investment, everything we do reduces risk.

  • The risk of losing a sale is reduced because of better availability.
  • The risk of product obsolescence is reduced due to lower inventory.
  • Financial risk is lowered due to lower investment.
  • The risk of wasting management attention due to misalignment of their staff is reduced because of the focused clarity of purpose expressed in the S&T.
  • The risk of turnover and its costs are likewise reduced as employees contribute more and appreciate each others’ contributions more.

So, when I approach a prospective investor with the opportunity for a 15x return over 3 years while accepting much lower risk in key areas, I am sometimes dismissed out of hand, even when my explanation focuses more on mitigating risk than the potential return.  Fortunately, enough people follow their common sense and not the common claim that there is a direct relationship between risk and return.  I think common sense wins out in the end because of the example of people like Warren Buffett, who became the second richest man in the world by prudently investing the proceeds from his paper route.  If you follow the man at all, you know that he is intensely risk averse.  Perhaps we can breathe life into a new truism “Reliable high returns require low risk.”