{"id":10374,"date":"2018-05-11T12:51:32","date_gmt":"2018-05-11T07:21:32","guid":{"rendered":"https:\/\/www.moneyworks4me.com\/investmentshastra\/?p=10374"},"modified":"2020-02-28T15:01:00","modified_gmt":"2020-02-28T09:31:00","slug":"what-are-the-different-risks-at-the-stock-level","status":"publish","type":"post","link":"https:\/\/www.moneyworks4me.com\/investmentshastra\/what-are-the-different-risks-at-the-stock-level\/","title":{"rendered":"What are the Different Risks at\u00a0the Stock-level?"},"content":{"rendered":"

The Rule No. 1 of Investing is, \u2018Never lose money.\u2019 And, the Rule No. 2 is, \u2018Never forget rule No. 1.\u2019 <\/em><\/strong>–\u00a0<\/span><\/em>Warren Buffett<\/span><\/strong><\/span><\/p><\/blockquote>\n

Your Stocks portfolio can have 7 types of risks:<\/span><\/h2>\n

(A) At Stock-level:<\/span><\/strong>\u00a0<\/span>1. Business Risk, 2. Valuation Risk and 3. Liquidity Risk
\n(B) At Portfolio-level:<\/span><\/strong>\u00a0<\/span>1. Asset Allocation Risk, 2. Market Cap Risk, 3. Sector Exposure,\u00a0and 4. Stock Exposure
\nSome risks help you earn good risk-adjusted returns, you need to manage them. Eliminate the rest!<\/p>\n

Let\u2019s understand\u00a0the risks at the Stock-level<\/strong><\/p>\n

1. Business Risk:<\/strong><\/span><\/h2>\n

Companies with poor fundamentals and weak business models are unable to deliver consistent and sustainable profitable growth. The company\u2019s poor performance could be the result of low or no sales growth, poor margins, inefficient management, inefficient capital allocation, etc. Investing in such stocks exposes your portfolio to the Business Risk.<\/p>\n

In the short term, it is possible that even substandard business gives temporary returns. But in the long term, a company\u2019s performance is reflected in its stock returns. As rightly said by Benjamin Graham, the father of Value Investing,<\/p>\n

\u201cIn the short term the market behaves like a voting machine, but in the long term it acts like a weighing machine.\u201d\u00a0<\/em><\/strong><\/p><\/blockquote>\n

Even large or prominent companies are not immune to business risk. Investing in companies with business risk means you run the risk of losing value from falling prices. The returns generated by buying healthy companies can be wiped out because of such bad investments.<\/p>\n

What kind of business should you invest in?<\/strong><\/span>\u00a0<\/span>Invest in a business that behaves like a compounding machine; companies that perform consistently and have sustainable earning power. Such performance will translate into higher market values and earn you compounded returns.<\/p>\n

2. Valuation\u00a0<\/strong>Risk:<\/strong><\/span><\/h2>\n

When a stock is over-priced compared to its fair value, your portfolio is exposed to Valuation Risk. It impacts return on investment, as the more over-valued the asset is, the lower the probability of returns for the investor. Over-valuation is usually a temporary phenomenon. Sooner or later, due to self-correcting mechanism, the price of such stocks fall, either gradually or often with a dramatic crash. If you have overpriced stocks, forming a large portion of your portfolio, the price- reduction will decrease value of your portfolio, even if the correction is only to its Fair Value.<\/p>\n

Don\u2019t believe\u00a0the myth<\/strong>\u00a0that you can time the market, sell at the highest price or get out at the peak. If you have access to the Fair Value of the company with\u00a0MoneyWorks4me\u2019s Superstars plan<\/a>,\u00a0compare it with the stock\u2019s current market price. This will help you gauge where the stock stands from a valuation perspective. To continue to earn good returns and avoid valuation risk, it is safer to,<\/p>\n