Simply
put, investment risk entails
the probability of losing
money, and the pain associated
with the loss.  Each
of us needs to know how
much money we can afford
to lose on any single investment.
We may be very comfortable,
for example, with buying
a lottery ticket even though
the risk is extremely high
because we can afford the
loss. Buying stocks, however,
is a lot different. We’re
using serious money when
investing in the market...money
that can make a difference
in our lifestyles. Once
we have established our
"tolerance for risk", we
can focus on assessing the
risks involved with individual
stocks.
Good information on stock
safety is hard to find.
Maybe that’s because it’s
the last thing anybody want
to think about. Even the
few credible sources that
provide some form of risk
analysis, do so subjectively.
Consequently, most investors
do little more than plug
intuition into their investment
decisions. It’s the missing
link in assessing stocks.
Knowing how safe (or risky)
a stock is can make the
difference between making
you a winner or loser as
an investor. Here are the
key factors used by VectorVest
in assessing stock safety.
EARNINGS
CONSISTENCY.
The largest risk that shareholders
have is that the company
fails to meet earnings expectations.
Experienced investors know
that the moment of truth
comes each quarter for every
publicly traded American
company. If a company fails
to meet analyst’s earnings
estimates, its stock’s price
often drops 30% in a single
day. Therefore, the single
most important factor in
assessing stock safety is
in quantifying the probability
that quarterly earnings
will meet investor’s expectations.
If a company has a well
established record of consistent,
predictable earnings performance,
it is much |
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more likely to meet the
market’s expectations. Companies
like Abbott Labs, Coca-Cola,
and McDonald’s have exemplary
records of consistent, predictable
earnings performance. These
stocks have very high Safety
ratings in the VectorVest
system of analysis. They
also have favorable ratings
in Value Line and in S&P’s
Stock Guide.COMPANY
SIZE.
It is true that the stocks
of large companies generally
are safer than those of
smaller companies. Many
fund managers are forbidden
to invest in companies with
less than $500 million in
annual sales. Obviously,
larger sized companies aren’t
going to disappear overnight.
Investors should not assume,
however, that the shares
of IBM, GM and Union Carbide
are safe just because they
belong to big companies.
Size is not nearly as important
to an equity investor as
knowing where the company’s
earnings are heading. It
is virtually impossible
to forecast the earnings
of IBM, General Motors and
Union Carbide with any degree
of accuracy. Therefore,
the VectorVest ratings on
these stocks are below average.
PRICE
BEHAVIOR.
The classic measure of price
volatility is given by "Beta."
Beta reflects the statistical
movement of a stock price
compared to the market.
If a stock’s price moves
up and down exactly in sync
with the market, it will
have a Beta of 1.00. If
a stock’s price consistently
moves up 10% more than the
market and down 10% more
than the market, it is more
volatile than the market,
and it has a Beta of 1.10.
Fair
enough. High Beta stocks
are more volatile than the
market, and less predictable.
Therefore, they are riskier
than the market. Ironically,
they are not necessarily
riskier than some low Beta
stocks. Certain stocks,
such as gold stocks,are
very volatile, but tend
to move counter to the market.
These stocks may |
