LONDON -- Over the past few weeks, I've been looking at how a number of FTSE 100 companies are addressing -- and communicating -- the risks that they face.
In short, I've been asking:
How many risks does the business deem significant enough to warn shareholders about?
- Which are the biggest risks facing the business?
- What is the business doing about those risks?
- And how well is the business communicating those risks -- and their treatment -- to shareholders?
It's been a fascinating series to research, and it's been interesting to see how businesses of a broadly comparable scale can come to some very different conclusions about how to deal with risk.
On your marks
Today, I'm going to score five of those companies on their treatment of risk. The companies in question: Vodafone (LSE: VOD ) , BHP Billiton (LSE: BLT ) , National Grid (LSE: NG ) , BG Group (LSE: BG ) , and AstraZeneca (LSE: AZN ) .
And the three measures that I'm going to use? In short, how well is management communicating to shareholders:
- The nature of the risks that they face?
- The potential impact of those risks?
- What they're doing about those risks?
And the example that I have in mind as I make these assessments? BP's annual report from 2009, which covered the subject of risk in just three pages, awarded some risks no more than a paragraph -- and gave no hint as to the scale of the potential downside that investors faced, following the Gulf of Mexico disaster in early 2010.
Here are the salient words, under the heading "Process safety":
Failure to manage these risks could result in injury or loss of life, environmental damage, or loss of production, and could result in regulatory action, legal liability and damage to our reputation.
Just last month, BP agreed to pay a fine of $4.5 billion -- the largest in American history -- in relation to the Gulf of Mexico disaster. The latest estimate that I've seen is that fines and compensation will cost the oil giant at least $42 billion. And the business that BP's shareholders own is now undeniably a much smaller one it was when those words were written.
So, on each metric, I'll award each company marks out of three. A top score, then, is nine points -- and a business awarded just three points (or less) has serious room for improvement. For something really distinctive, I'll throw in an extra bonus point.
How they fared
Vodafone does a decent job. The company clearly articulates the risks that it faces (2 out of 3), and an equally decent job of communicating to shareholders what those risks mean in terms of their impact on performance (2 out of 3).
Finally, Vodafone makes a decent fist of describing what it is doing in mitigation, especially at the level of the individual risks concerned (2 out of 3). Total score: 6 out of 9.
BHP Billiton treats risks seriously, and communicates them clearly. Instead of impenetrable legalese, BHP Billiton won plaudits for describing risks in clear, easy-to-understand language (3 out of 3), and communicating the consequences of those risks in equally clear language, often quantified by numbers (3 out of 3).
Although slightly less impressive, risk mitigation is handled credibly, being the subject of a separate section of the report, and scoring 2 out of 3. While I accept that it makes sense to group some risks together from the mitigation point of view, there's a resulting lack of one-to-one correspondence and loss of focus. Total score: 8 out of 9.
National Grid delivers the goods. National Grid, like BHP Billiton, does a good job of enumerating and communicating the risks that it faces (3 out of 3). That said, the impact of those risks was less clearly articulated, and in my view lacks the very helpful level of quantification provided by BHP Billiton -- so here, National Grid scored just 2 out of 3.
As with BHP Billiton, risk mitigation is the subject of a separate section. I'd like to have seen a few more numbers, but the overall treatment is reasonable enough, scoring 2 out of 3. Total score: 7 out of 9.
BG Group does a decent job. The company does a reasonable job of describing and enumerating risks (2 out of 3), and a creditable job of analysing and communicating the impact of those risks (2 out of 3).
Also competent is the company's treatment of mitigation, earning it another 2 out of 3. Overall, a few numbers would have been helpful, but a decent job done. Total score: 6 out of 9.
AstraZeneca is clear on risks, but opaque on mitigation. AstraZeneca clearly informs shareholders of the risks that their investment faces, using language that is reasonably easy to understand (2 out of 3). And the company's treatment of the impact of those risks is hard to fault, being highlighted in a separate section, again in easy-to-understand language (3 out of 3).
But its record is tarnished by its treatment of mitigation. What is the company doing about the risks it faces? Beyond oblique references to footnotes in the financial accounts, and references to paragraphs in the operational reviews contained a hundred pages previously, information is scant. By inference, there are things going on -- but their adequacy is difficult to judge. On this aspect, then, AstraZeneca scores 1 out of 3. Total score: 6 out of 9.
Overall, BHP Billiton and National Grid emerge as the more reassuring companies of the five covered here. They make a reasonable fist of communicating the risks that they face, and of estimating the impact of those risks, falling down only on certain aspects of their approach to risk mitigation.
Elsewhere, the picture isn't quite so rosy. Achieving very comparable total scores, BG Group, Vodafone and AstraZeneca emerge as competent, but no more. And no company managed top marks -- a feat so far achieved by just Tesco.
Risk vs. reward
Two superstar investors who are well-used to weighing risks are Neil Woodford and Warren Buffett.
On a dividend re‑invested basis over the 15 years to Dec. 31, 2011, Neil Woodford delivered a return of 347%, versus the FTSE All‑Share's distinctly more modest 42% performance. Warren Buffett, for his part, has delivered returns of over 20% per annum since 1965, transforming himself into the world's third-wealthiest person.
Each, as it happens, are the subject of two special reports prepared by Motley Fool analysts. And they're yours to freely download, without any obligation.