Saturday, 17 January 2015

Concept of "Risk." Market price fluctuation is NOT risk.

It is conventional to speak of good bonds as less risky than good preferred stocks and of the latter as less risky than good common stocks.

From this is derived the popular prejudice against common stocks because they are not "safe."

The words "risk" and "safety" are applied to securities in two different senses, with a resultant confusion in thought.

A bond is clearly proved unsafe when it defaults its interest or principal payments.

Similarly, if a preferred stock or even a common stock is bought with the expectation that a given rate of dividend will be continued, then a reduction or passing of the dividend means that it is unsafe.

It is also true that an investment contains a risk if there is a fair possibility that the holder may have to sell at a time when the price is well below cost.

Nevertheless, the idea of risk is often extended to apply to a possible decline in the price of a security, even though the decline may be of a cyclical and temporary nature and even though the holder is unlikely to be forced to sell at such times.

These chances are present in all securities, other than United States Savings Bonds, and to a greater extent in the general run of common stocks than in senior issues generally.

But we believe that what is here involved is not a true risk in the useful sense of the term.


The man who holds a mortgage on a building might have to take a loss if he were forced to sell it at an unfavourable time.  That element is not taken into account in judging the safety or risk of ordinary real-estate mortgages, the only criterion being the certainty of punctual payments.

In the same way the risk attached to an ordinary commercial business is measured by the chance of its losing money, not by what would happen if the owner, were forced to sell.

We would emphasize our conviction that the bona fide investor does not lose money merely because the market price of his holdings declines; the fact that a decline may occur does not mean that he is running a true risk of loss.


If a group of well-selected common-stock investments shows a satisfactory over-all return, as measured through a fair number of years, then this group investment has proved to be "safe".

During that period its market value is bound to fluctuate, and as likely as not it will sell for a while under the buyer's cost.  

If that fact makes the investment "risky" it would then have to be called both risky and safe at the same time.


This confusion may be avoided if we apply the concept of risk solely to a loss of value which either:
(a) is realized through actual sale or 
(b)  is ascertained to be caused by a significant deterioration in the company's position.

Many common stocks do involve risks of such deterioration.

But it is our thesis that a properly executed group investment in common stocks does not carry any substantial risk of this sort and that therefore it should not be termed "risk" merely because of the element of price fluctuation.

Benjamin Graham
The Intelligent Investor

No comments: