The Disadvantages of Stock Ownership

There are some disadvantages of common stock ownership.

1.  Risk

Risk is perhaps the most significant.

Stocks are subject to various types of risk, including:

• business and financial risk,
• purchasing power risk,
• market risk and 
• event risk.

All of these can adversely affect 

• a stock's earnings and dividends, 
• its price appreciation and 
• of course, the rate of return that you earn.

Even the best of stocks possess elements of risk that are difficult to eliminate because company earnings are subject to many factors, including:

• government control and regulation,
• foreign competition and
• the state of the economy.

Because such factors affect sales and profits, they also affect stock prices and (to a lesser degree) dividend payments.

2. Price & Returns Volatility

All of this leads to another disadvantage: stock returns are highly volatile and very hard to predict, so it is difficult to consistently select top performers.

The stock selection process is complex because so many elements affect how a company will perform.

In addition, the price of a company's stock today reflects investors' expectations about how the company will perform.

In other words, identifying a stock that will earn high returns requires that you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) but also that you can spot that opportunity before other investors do and bid up the stock price.

3. Current income

A final disadvantage is that stocks generally distribute less current income than some other investments.

Several types of investments - bond, for instance - pay more current income and do so with much greater certainty.

Comparing the dividend yield on common stocks with the coupon yield on high grade corporate bonds from 1976 to 2012,  shows the degree of sacrifice common stock investors make in terms of current income.

Clearly, even though the yield gap has narrowed a great deal in the past few years, common stocks still have a long way to go before they catch up with the current income levels available from bonds an most other types of fixed-income securities.

Message:  

In other words, identifying a stock that will earn high returns requires that:

• you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) 
• but also that you can spot that opportunity before other investors do and bid up the stock price.