Showing posts with label risk avoidance. Show all posts
Showing posts with label risk avoidance. Show all posts

Sunday 22 September 2019

Companies to avoid

Avoid these companies described below.  That is not to say there are no good investments to be found, but the chances of this happening are much lower, increasing the risk of us running into a dud.

Some examples are as follows

1,  Companies with an excessive growth focus.

Growth is good and beneficial if it is the result of a job well done, which generates resources over time which are reinvested increasing the strength of the company, but this tends to be more the exception than the rule.  The obsession with high growth targets is extremely dangerous.   Once again there is an agency problem:  who are the company's management working for - themselves or the shareholders?  Growth is only a good thing if it is healthy.


2.  Companies which are constantly acquiring other companies.

If the acquisition is not focused on increasing the competitive advantage of the main business, it can end up becoming a rueful folly, or what Peter Lynch calls 'diworsification', diversifying to deteriorate.
Growth ca also ring with it two other problems:  first, more complex accounting can more easily conceal problems; and second, each acquisition eds up becoming bigger than the last, increasing the price and therefore the level of risk.

It is worth reiterating ow detrimental it can be when some mangers feel the pressure or the desire - after selling a substantial part of the company - to buy another of a similar size, instead of returning the money to the shareholders.


3.  Initial public offerings

According to a study, companies who float on the stock market via an IPO post 3% lower returns than similar companies after 5 years. 

There is a simple reason for this:  there are clear asymmetries in the information available to the seller and what we know as purchasers.  The seller has been involved with the company for years and abruptly decides to sell at a time and price of their choosing.  The transaction is so one[sided that there can only be one winner.

4.  Businesses which are still in their infancy.

Old age is an asset: the longer the company has been going, the longer it will last in the future.  A recent study shows that there is a positive correlation between the age of a company and its stock market returns.  It takes a  certain amount of time for a business to get on to a stable footing, depending on the level of demand and competition.  Until this happens, we are exposed to the high volatility inherent in any new business, with an uncertain final outcome.

5.  Businesses with opaque accounting.

Whenever there's significant potential for flexible accounting, being ale to trust in the honesty of the managers and/or owners is essential.

Long-term contractors in the construction sector, or in infrastructure or engineering projects, are examples where there is scope for flexible accounting, with latitude to delay accounting for payments or being forward income.

We can include banks and insurance companies in this category, where the margin for accounting flexibility is very significant and it is relatively simple to cover up a problem for a while, compounded by having highly leveraged balance sheets.

Prior to investing in these types of businesses, it is absolutely imperative to be certain we can trust the mangers or shareholders.  No one forces us to invest in them, so the burden of proof is on the company.

6.  Companies with key employees.

These are companies where the employees effectively control the business, but without being shareholders (the latter could even be positive).  For example,, many service companies reportedly have very high returns on capital, ut only because capital isn't necessary:  investment banks, law firms, some fund managers, consultancy companies, head-hunters, etc.

The creation of value in these businesses benefits these key employees, while the opportunities for external shareholders to earn attractive returns are limited, despite supposedly high returns on capital employed.

7.  Highly indebted companies.

"First give me back the capital, then return something on it."

Buffett also remarks that the first rule of investing is not losing money and the second and the third ..

Excess debt is one of the main reasons why investments lose value.  We do not need to flee from debt at every opportunity, when it is well used it can be very helpful, but it should not have much weight in a diversified portfolio. 

By contrast, markets don;t particularly like companies to hold cash rightly fearing that such financial well-being might lead to bad investment decisions. 

{To sleep well and to make the most of incorrect market valuation, ensure that over half of the companies in the portfolio have ample cash.  Do not be worried about excess cash, provided that capital is reliably allocated.}

8.  Sectors which are stagnant or experiencing falling sales.  

While it is not worth paying over the top for growth, on the flipside, falling sales can be very negative.  Quite often these companies can cross our radar because of the low prices at which they are trading but over the long term, time is not on our side with them..  Sometimes sales will recover but mostly the opportunity cost is to high, given that the situation can persist for sometime.

9.  Expensive stocks.

It is obvious but worth spelling out.  In reality, expensive companies have historically obtained the worst results, because good expectations are already priced in and because it is less likely that the price will jump from - say- a P.E ratio of 16 to 21 than from 9 to 14.

That is not to say that good results cannot be obtained from buying the above types of stocks, but it is an additional hurdle which some may preferred to avoid.


The above are not the only examples of companies to avoid,, but they are a good starting point.



Thursday 15 December 2016

An Acceptable Level of Risk

Individuals differ in the amount of risk that they are wiling to bear and the reurn that they require as compensation for bearing that risk.


1.  The risk-indifferent investor requires no change in return for a given increase in risk.

2.  The risk-averse investor requires an increase in return for a given risk increase.

3.  The risk-seeking investor gives up some return for more risk.


The majority of investors are risk averse.

The historical data on the risk and return of different investments from all over the work indicate that riskier investments tend to pay higher returns.

This simply reflects the fact that most investors are risk averse, so riskier investments must offer higher returns to attract buyers.



How much additional return is required to convince an investor to purchase a riskier investment?

The answer to that question varies from one person to another depending on the investor's degree of risk aversion.

A very risk-averse investor requires a great deal of compensation to take on additional risk.

Someone who is less risk averse does not require as much compensation to be persuaded to accept risk.

Thursday 16 August 2012

Risk is Manageable: Manage Risk Actuarially

Risk avoidance strategy:  Manage Risk Actuarially

This way is to act, in effect, like an insurance company.

An insurance company will write a life insurance policy without having any idea WHEN it will have to pay out.  It might be tomorrow; it might be 100 years from now.  It doesn't matter (to the insurance company).

The insurance company controls risk by writing a large number of policies so that it can predict, with a high degree of certainty, the AVERAGE amount of money it will have to pay out each year.

Dealing with averages, not individual events, it will set its premium from the AVERAGE EXPECTANCY of the event.  So the premium on your life insurance policy is based on the average life expectancy of a person of your sex and medical condition at the age you were when you took out the policy.  The insurance company is making no judgement about YOUR life expectancy.

The person who calculates insurance premiums and risks is called an actuary; thus calling this method of risk control "managing risk actuarially."

This approach is based on averages of what's called "risk expectancy."

The Master Investor using this way of managing risk is actually looking at the AVERAGE PROFIT EXPECTANCY.

Risk is Manageable: Actively Managing Risk

Risk avoidance strategy:  Actively Managing Risk

This is primarily a trader's approach - and a key to Soros's success.

Managing risk is very different from reducing risk.  If you have reduced risk sufficiently, you can go home and go to sleep.  Or take a long vacation.

Actively managing risk requires full-focused attention to constantly monitor the market (sometimes minute-by-minute); and the ability to act instantly with total dispassion when it's time to change course (when a mistake is recognised, or when a current strategy is running its course).

Soro's ability to handle risk was "imprinted" on him during the Nazi occupation of Budapest, when the daily risk he faced was death.

His father, being a Master Survivor, taught him the three rules of risk which still guide him today:
1.  It's okay to take risks.
2.  When taking a risk, never bet the ranch.
3.  Always be prepared to beat a hasty retreat.


Risk is Manageable: Reduce Risk

Risk avoidance strategy:  Reduce Risk

This is the core of Warren Buffett's entire approach to investing.

Buffett invests only in what he understands, where he has conscious and unconscious competence.

But he goes further:  his method of avoiding risk is built into his investment criteria.  He will only invest when he can buy at a price significantly below his estimate of the business's value (the intrinsic value). He calls this his "Margin of Safety."

Following this approach, almost all the work is done BEFORE an investment is made.  (As Buffett puts it:  "You make your profit when you buy.")  

This process of selection results in what Buffett calls "high probability events":  investments that approach (if not exceed) Treasury bills in their certainty of return.

Risk is Manageable: Don't Invest

Risk-avoidance strategy:  Don't Invest

This strategy is always an option.  Put all your money in Treasury bills - the "risk-free" investment - and forget about it.

It is practised by every successful investor when they can't find an investment that meet their criteria, they don't invest at all.

Even this simple rule is violated by far too many professional fund managers.  For example, in a bear market they'll shift their portfolio into "safe" stocks such as utilities, or bonds ... on the theory they'll go down less than the average stock.  After all, you can't appear on Wall Street Week and tell the waiting audience that you just don't know what to do at the moment.