We help our Premium Members navigate investment risk by interviewing company management, dissecting conference calls, interacting with our wide network of savvy investors and scouring SEC documents for hidden clues.Too often investors focus on returns and ignore the risk element of the wealth creation equation. Anyone who has invested in equities surely has a story where the positive returns from an investment accumulated over months were wiped out from the occurrence of a defining “risk” event. And you say to yourself, “I wish I would have known this risk existed.” The topic of risk is most evident when investing in micro-cap stocks. This space can be riddled with “junk” and less than honest CEOs. Understanding the unique investment risk (s) of a potential investment will help define your sell discipline and invest with more confidence.
Identify Business Risk
The first step in the risk process is identifying the boilerplate business and investment risk factors that can be associated with most companies on a broad basis. For example, customer concentration, how seasonality impacts quarterly numbers, sensitivity to economic forces and desire to raise capital.
Find The Financial Risks
The second step is to find financial risks that are unique to the company such as contract duration, health of balance sheet, profit margin issues and the quality of reported financials. Consider the following scenario. You bought a stock that benefited from a government contract that will soon come to an end. The stock is up 100% fueled by superior sales and earnings growth over the past several quarters. The savvy investor who has access to knowledge that the contract will soon end would probably consider locking in some gains. The investor who lacks this knowledge may hold the stock and lose the entire gain in one trading session when the company reports weak financial results due to the absence of the contract.
In essence, the knowledge of investment risk factors will help you define your discipline. And the faster you acquire this knowledge before the next person, the more likely you are to get the upper hand.
Judge Opportunity Risk
The perception of investment risk is also a misunderstood topic. An investor that can identify companies/events that investors have improperly defined as risky can swoop in and buy cheap shares from misinformed investors and sell back to them at higher prices when they later realize their mistake. There are instances where a stock may fall due to a seemingly poor quarterly financial report, but information in the related CC infers that the reason was a one-time event and that superior results will occur immediately.