Here’s An Investing Lesson You Can Take From Silicon Valley Bank’s Collapse

The postmortems are well underway now, and already some investing lessons from Silicon Valley Bank’s (SVB) stunning collapse are emerging. And there’s one that stands out above the others for me: I just don’t get how SVB’s highly clustered customer base (with so many clients hailing from the same industry) managed to go so unnoticed.

Of course, hindsight is 20/20, but it’s always important to assess customer concentration when analyzing investment risk. In fact, if, like me, you’re a practitioner of the quality style of investing (basically, buying stable, predictable, and profitable growth firms), you’ll know that a study of supplier and customer concentration is right up there at the top of the checklist. You’ll also know that the more diversified, the better on both counts. No one wants to be at the mercy of overly powerful customers or suppliers, after all.

Industry-facing firms making specialized equipment mightn’t have any choice but to sell to just one or two industries. But that’s generally pretty obvious, and when industry concentration is unavoidable, firms try to limit their exposure to any one customer. As an investor, it's important to look out for these stats (they’re usually discussed in the risks section of a firm’s annual filings, so they’re not exactly hard to find). A rule of thumb is to be especially careful if one customer represents more than 10% of sales. It’s the same when it comes to consumer-facing businesses, like banks. Here, no single customer is ever likely to represent an overly risky amount of revenue, and that makes sense, but clusters of similar customers should also be a cause for concern. They’re likely to be impacted by the same types of things, after all.

Now, I’m no bank analyst, but I’d like to think I’d have spotted SVB’s highly concentrated customer base, had I analyzed the firm. (I mean, it’s right there in the name). And I’d have hoped another question would’ve sparked in my mind: hasn’t the tech startup world experienced something of a bubble since the pandemic crisis, and so, wasn’t it always possible that some of those funded startups could run into trouble?

To be fair, those thoughts probably wouldn’t have led me to SVB’s deposits, and I’d probably have concluded that the bank's assets (mostly government bonds) looked rock solid. But the point is this: I wouldn’t have even made it that far. The bank's customer concentration would have been a big flapping red flag, and I would’ve said thanks, but no thanks.