You Have Been Explained Risk Incorrectly

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The Standard Measure of Risk

Investors have been told that risk can be defined with a blanket metric called beta.  Beta is a metric that refers to the volatility of a stock and the market by comparison.  Why do we care about this?  I will list the reasons why an individual might be concerned with beta:

  1. They are retiring and need to withdraw their capital in a very short time period.

That's right.  There is only one reason why someone should be concerned with beta.  This is because the beta on a particular company's stock has generally very little correlation with the actual risks of the inherent business model.

Actual Risks

Even though all investment advisory firms uses beta as a standard measure, they are only trying to attract clients who want "low volatility".  This is all garbage.  Now lets talk about actual risk to consider when holding a business in your portfolio.  

  • Negative or declining earnings and revenue.  A companies competitive edge may be slipping and their income statement is reflecting this.

  • High debt to equity levels.  When the tide comes in, you will see who is wearing pants.

  • Dividend cuts.  Management clearly believes they need that extra cash  to stay afloat or grow.

  • Political turmoil.  Does the country that the company operate in have legislation incoming to greatly compromise their profitability?

  • Competitors.  Is there disruptive technology that will greatly take away market share?

There are more actual risks to a business, but these are just a few questions investors must ask themselves before purchasing an equity position.  It is unfortunate that the financial advisory world uses one metric to put a blanket statement on the risks associated with a certain company.  

Opportunities

As the financial advisory world tends to buy low beta stocks for their worrisome clients, opportunity can arise with higher beta stocks with perfect financial health.  Remember, this doesn't mean the company is risky, their price just tends to fluctuate more than the market average.  This will create undervalued stocks generally with smaller market capitalization where advisory firms are not purchasing these kinds of companies for their clients.  

Bottom Line

Do not let the financial advisory firms of the world convince you that a certain company may be risky or safe due to the beta.  Knowing the company well before purchasing it will open an investor up to risks and opportunities that are inherent to the actual company in question.  Do quality research, understand the financial statements and act on opportunities.