Always look at the risks before looking at the rewards in your long term investing

In investing, always look at the risks before looking at the rewards.

Understand the risks you are taking and then decide for the potential rewards you can hope to get, whether this reward/risk ratio makes business or investing sense.

Also, determine what is the likelihood of the reward appearing, its quantum and when.

Remember, "a bird in the hand today is worth two or more in the bush tomorrow."



How to look at risks in investing?

Back to the teaching of Warren Buffett's 4 tenets of his investing method.

1.  Understand the business.
2.  A business having durable competitive advantage.
3.  Managed by people with integrity.
4.  Available at fair price (margin of safety).

His tenets are very simple, and yet so few are following these.


If the business is too hard to understand, avoid investing into it.  You need to be able to understand the business.  What are the products or services it is selling?  Who are its customers?  How are its revenues generated?  Its profit margins?  Who are its competitors?  Only invest into a company you understand.  This is having business sense.

A company with durable competitive advantage enjoys certain unique advantages that allow it to compete in its competitive business environment.  The company may be selling a unique product or service, protected by patents or it enjoys a brand that people like for a long time.  Perhaps, the business is the lowest cost producer, or the cost of switching by its customers to another competitor is high.  Some businesses enjoy networking effect.  Avoid businesses with no durable competitive advantage.

People with integrity can be difficult to judge with certainty.  In general, a reputation build up slowly over 30 years can disappear over 5 minutes.  Anyone whom you have even a slight suspicion of his integrity, just avoid investing into that company.

When all the above 1, 2, and 3 tenets are met, you can then determine the price to buy and how much to buy?  You need to be patient.  The market is volatile and stock prices are volatile.  These market volatility and price volatility reflect the fluctuating sentiments of the investors and players in the market.  Don't time the market, always price the market.  You buy when the price is right.  Avoid when the price is obviously too high.  Invest when a great company is available at a fair price or even a slightly above fair price.  Be greedy and invest a lot, when a great company is available rarely at a huge bargain price.



Managing risks

The above few paragraphs explore how you will manage risks as applied to each tenets of Buffett in your stock investing.  In a very general sense, risks can be managed in 4 ways:

1.  Avoid
2.  Retain or embrace
3.  Reduce
4.  Transfer.

Whenever you are prospecting a new stock, you will need to determine that this stock meets the 4 business tenets of Buffett.  At each stage, you should avoid this stock altogether if you determined its risk is too high.

• Note that not able to understand the company's business is high risk too and you will need to avoid investing into it.  
• Not able to determine what confers to it its long term durable competitive advantage, is also another investing risk that should be avoided or perhaps embraced sometimes, but you need to have a very good reason.  
• Of course, avoid counters managed by people whose integrity you doubt.  
• Not able to value the business either because it is too complex to understand or its accounting is too difficult to fathom, you are better to avoid investing into this company.

Eventually, you are left with those stocks which you understand very well.

• QUALITY OF THE COMPANY (QUALITATIVE ASSESSMENT):  You understand their businesses, their durable competitive advantages and their management.  
• VALUATION OF THE COMPANY (QUANTITATIVE ASSESSMENT):  And, you too understand how to value them and this gives you an advantage to buy and own them at a reasonable, fair or good prices.  

Every stock you own has gone through this thorough risk analysis and also the reward potential analysis.  For the stocks you have in your long term portfolio, you have retain and embrace the risks associated with investing in them and also have a very clear idea of their reward potentials.  You know their risk/reward ratios over the long term and the probability of their investing returning  predictable positive returns (driven by the durable competitive advantage possessed by these companies).

When the stocks in your portfolio are priced too high during certain market situations, you may, if you wish to, also reduce the risks or transfer the risks using various strategies.


Through managing your risks, you avoid losses or minimise your losses and the modest positive returns from the other stocks in your portfolio will translate into reasonable returns.

Investing is fun and profitable in the long run.

Good luck to all.

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

Would you rather be with Andrew or Linda? Businesses manage their finances just like individual people. :-)

Predicting the future networth of these individuals.

Andrew: Risky to Predict

Linda: Less Risky to Predict



Just because a business has volatile numbers doesn't mean it won't make a lot of money in the future.

It's just more difficult to predict and value = RISK.

Buffett Rule: A Stock must be stable and understandable.

Risk is Manageable: Risk-Avoidance Strategies

Master Investors use one of the four-risk avoidance strategies:
1.  Don't invest.
2.  Reduce risk (the key to Warren Buffett's approach).
3.  Actively manage risk (the strategy George Soros uses so astonishingly well).
4.  Manage risk actuarially.

There is a fifth risk-avoidance that is highly recommended by the majority of investment advisors:  diversification.  But to Master Investors, diversification is for the birds.

No successful investor restricts himself to just one of these four risk-avoidance strategies.  Some - like Soros - use them all.

Warren Buffett - There is Only One Type of Investment Risk

Do yourself a favour, invest in your financial education before you invest in the markets

"Risk comes from not knowing what you are doing." 

Risk can be alleviated with proper education and experience.  This is the same process that you must commit to undertake when you decide to invest in any market.  First and foremost, you must get yourself educated.

It is strange that most parents would not think twice to pay high school fees to send their kids to university, when there is no real guarantee that they will succeed in life after getting their degree.  However, when it comes to paying for financial education, where there is a chance they can lose all of the kids' education funds, many people shy away because of the price.  Instead, they would rather risk their hard earned money in a market or instrument that they have little knowledge of, or worse, investing based on rumours or tips from various unverified sources.

Most people are attracted by the myth of quick, easy money from investing (or trading) but fail to understand that it takes a lot of hard work to be successful.  Everyone equates being a doctor or lawyer to earning lots of money.  But it is also common understanding that to be a doctor or a lawyer requires one to put in many years of education and practice before one can be successful.  Ask anyone about his or her current job and you would most likely get the same response that hard work is the norm.  How then can it be different for investing (and trading)?

"Risk comes from not knowing what you are doing" - a famous quote from Warren Buffett.  
It sounds simplistic, but it epitomises the real meaning of the work "Risk".

Any instrument, be it stocks or forex will be dangerous if you don't know what you are doing.  it is not the instrument but the level of the investor's understanding of the instrument and the market that determines his risk level.  So, do yourself a favour, invest in your financial education before you invest in the markets. 

Here is another quote from Mr. Buffett:  "The most important investment you can make is in yourself.."

The Risk is Not in The Car; It is the Driver Behind The Wheel.

It would be a risky situation if a person decides to drive a car without having undergone any form of training.  It is the person's lack of knowledge and skill that makes the situation risky and not the car.

Similarly, if someone wants to invest (or trade) in a particular instrument but has not undergone any form of training, this person would be assuming a higher risk, and it has nothing to do with the instrument.  It is often the lack of knowledge and skill that makes investing (and trading) risky and not the instrument itself.


What is risk in the context of investing?

Risk is a quantifiable entity.
People associate risk with uncertainty in outcome or expected return.  A fixed deposit gives an expected return that is certain but not stocks.
People associate risk with volatility.  Yes, this too can be risky for those who do not understand volatility and who fall folly to it, rather than taking advantage of it.


Risk in investing is thus generally defined as:  


"The quantifiable likelihood (probability) of loss or less-than-expected returns."  
The keyword here is uncertainty in outcome or expected returns.

How to be a good investor?

To be a good investor (and trader), one must first seek knowledge about the instrument that one is going to invest in (or to trade).  It is similar to taking on a new job.

• First, you must learn what your new role is all about, what kind of tools are there to help you in your everyday routines, what are the skill sets needed to perform your new job properly, etc.  
• After that, once you have acquired the knowledge and learnt the skills required, you still need a period of constant practice to apply your newly acquired knowledge and hone your new skills.  
• It is only after having practised for a sustained period of time before one is able to get the "feel" of the job and perhaps do it with ease and confidence.

Risk comes from NOT knowing what you are doing.
Enter at your own risk.

Don't be afraid of risk. Learn how to manage it.

Don't be afraid of risk. You will face some kind of risk no matter what you do with your money. Fear of risk can sometimes paralyze your investing. You end up watching your money lose value solely because you missed investment opportunities and let the money sit in a safe savings account, earning less interest than the inflation rate.

The least you need to know:

1. Get to know the types of risks you face as  a value investor, but don't be afraid of them.
2. No investor can avoid risk, but you can learn how to manage it.
3. Time can heal many investment woes, as long as you have the patience to wait out an investment storm.

A Brief Look at Malayan Banking Bhd

Malayan Banking Berhad Company

Business Description:
Malayan Banking Berhad (Maybank) is engaged in the business of banking and finance. Through its subsidiaries, Maybank operates in six segments, which include

1. consumer banking, 
2. business and corporate banking, 
3. global market, 
4. investment banking,
5. insurance and asset management and 
6. international banking. 

Its global market segment comprises the full range of products and services relating to treasury activities and services, including foreign exchange, money market, derivates and trading of capital market instruments. Its investment banking segment comprises the business of an investment bank, discount house and securities broker. Its insurance and asset management segment comprises the business of underwriting all classes of general and life insurance, offshore investment life insurance, general takaful and family takaful, asset and fund management, nominee and trustee services and custodian services.

Current Price (7/1/2011): 9.00
Employees: 40,000
Market Cap: 65,900,163,519
Shares Outstanding: 7,322,240,391
Closely Held Shares: 4,362,026,586

2004 DPS 30.6 EPS 47.7
2005 DPS 53.7 EPS 47.6
2006 DPS 43.3 EPS 52.2
2007 DPS 41.3 EPS 57.8
2008 DPS 32.1 EPS 58.3
2009 DPS 6.00 EPS 33.5
2010 DPS 55.0 EPS 53.94
1Q11 DPS - EPS 14.53 NTA 4.0007

Estimated EPS for FY 2011 4*14.53 = 58.12 sen
Projected PE for FY 2011 = 15.5 x

Historical
5 Yr
PE range 11.3 - 17.4
DY range 5.4% - 3.6%

10 Yr
PE range 14.1 - 20.4
DY range 4.7% - 3.4%

Recent Financial Results

Announcement Date		Financial Yr. End		Qtr	Period End		Revenue RM '000		Profit/Lost RM'000		EPS		Amended
12-Nov-10		30-Jun-11		1	30-Sep-10		5,001,923		1,053,640		14.53		-
20-Aug-10		30-Jun-10		4	30-Jun-10		4,737,314		975,033		12.89		-
13-May-10		30-Jun-10		3	31-Mar-10		4,586,454		1,063,284		14.56		-
09-Feb-10		30-Jun-10		2	31-Dec-09		4,671,338		1,023,380		14.04		-

Capital Changes

2008 1/4 Bonus

2009 9/20 Rights @ RM 2.74

Related reading:

Risk comes from misjudgement of a company's prospects, not price volatility

Simple ways to value stocks and shares

The fundamental basis of value

Stocks and shares confer the right to receive money in the future, and it's this ability to put money in your pocket that gives them their value.  Specifically, the value of a stock is the value of each of those future bits of money all added together.

This is where things start to get a bit tricky, because the value of money you are going to receive in the future depends on three elements:

• how much it is
• when you actually receive it (time value of money) and 
• the return you plan to make in the meantime (internal rate of return or the discount rate).  

For illustration, you plan for your money to make 10% each year.  This is the internal rate of return or the discount rate, depending on which end of the sums you're coming from.  The key point is that a payment of $161.05 in five years' time would have a value today of $100 if you wanted it to deliver a return of 10% a year.

• If you paid more than that then you'd make less than 10%; 
• if you paid less, you'd make more than 10%; and
• if you paid a lot less, you'd make a lot more than 10%.  That's value investing.

When you get a payment that repeats every year, forever, something really handy happens:  the sum of all the individual payments simplifies down to just one payment divided by your discount rate.  

If the payments received are growing - at least if you assume they'll grow at the same rate each year:  you just divided the first payment by the difference between the discount rate and the growth rate (the growth rate effectively offsets part of the discount rate).


The return you plan to make.

For money you plan to commit to the share market, we'd recommend using the long-term return from shares as your discount rate (your "opportunity cost of capital").

• We think 10% is a nice round number to aim for. 
• As long as you choose something in the ballpark of 8 to 12%, though, most of any difference should get lost in the rounding.

Don't confuse value and risk.

Conventional theory says you should finetune your discount rate for different shares, using a higher discount rate for riskier stocks and vice versa, but we think that just confuses the issue.  If something is riskier than something else, it doesn't necessarily mean it has a lower value, it just means that the value is more variable.

How you deal with risk for any particular stock depends on your margin of safety, your diversification and how much risk you're prepared to take.  To understand how these factors all stack up, though, you need to put all stocks on a level playing field in the first place by valuing them on the same basis - which means using the same discount rate.


Related:

• Value Investing is about Buying Stocks for less than they're worth
• Simple ways to value stocks and shares
• Value in the context of Your Overall Portfolio

The numbers speak for themselves: Keeping an eye on the holdings of Warren Buffett is a good idea.

Although the name Berkshire Hathaway is not synonymous with its chairman and CEO, Warren E. Buffett--the greatest investor of all time--it definitely should be. Despite Berkshire’s origins in the textile industry it was not until 1964, when Buffett stepped into the driver’s seat of this holding company, that Berkshire really started to post astonishing gains year in and year out.

Buffett’s investing ideals are by no means original. He is the prodigy student of Ben Graham, the father of value investing, but Buffett's educational influences did not stop there. He combined what Graham taught with the investment principles of Philip Fisher. Fisher focused on what a company did and how it made money, stressing the qualitative fundamental characteristics of companies. By combining the teachings of both Graham and Fisher, Buffett, through his Berkshire investing vehicle, has been able to post unfathomable annual returns.

In adhering to the principles of value investing, Buffett is the personification of patience and discipline, two characteristics often in short supply in money managers. His buy-and-hold strategy had proven extremely profitable over the last 40 years. Berkshire’s so-called “bread and butter” is the insurance business, and amongst other insurance companies, Berkshire wholly owns the GEICO Corporation. The reveune from this stream of business was over $1.5 billion in 2004. But do not let this mislead you; Buffet shows little hesitation to invest in other sectors of the economy, as long as he feels he is getting a good deal. View Buffett's holdings now - click here.

Some of the most important factors value investors analyze are such things as ROE, debt-to-equity and price-to-book ratios, all in an effort to determine a company’s intrinsic value. If Buffett deems a company’s intrinsic value to be higher than its current price, and its management and business operations to be sustainable, he will almost certainly invest. However, based on his staple of only about 30 stocks, it is fairly apparent that very few companies pass the Warren E. Buffett invest-ability test.

Although we can talk all about Buffett’s accolades over the past 40 years, the numbers speak for themselves. Suffice to say that keeping an eye on the holdings of Warren Buffett is a good idea. If you are not watching the best investor in the world, who are you watching?

Berkshire Hathaway	Average Annual Return	3-Year	5-Year
Common Stock (BRK.a/b)	21.9%	8.48%	9.48%
S&P 500(Benchmark)	10.4%	17.17%	0.64%

Company Name:	Berkshire Hathaway
Portfolio Manager:	Warren Buffett
Focus:	Value
Updates:	Shares Held, Change in Shares, and Position Change as of 9/30/08 - all other information 15 minutes delayed

Ticker	Company	Share Value x1000	Change in Value x1000	Current Value x1000	Shares Held	Change in Shares	% of Portfolio	Position Change
COP	ConocoPhillips	$5,710,262	$5,710,262	$4,438,024	77,955,800	77,955,800	8.17%	Increase
PG	Procter & Gamble Co.	$5,592,762	($843,794)	$4,816,725	80,252,000	(25,595,000)	8.00%	Decrease
KFT	Kraft Foods Inc.	$3,930,416	($3,436)	$3,643,586	120,012,700	(18,259,800)	5.62%	Decrease
WFC	Wells Fargo & Co. Del	$2,481,957	($4,421,097)	$1,835,180	66,132,620	(224,522,248)	3.55%	Decrease
WSC	Wesco Finl Corp.	$2,036,002	($145,429)	$1,919,089	5,703,087	0	2.91%	No Change
USB	US Bancorp	$1,781,615	($132,505)	$1,148,504	49,461,826	(19,169,200)	2.55%	Decrease
JNJ	Johnson & Johnson	$1,703,512	($2,269,769)	$1,474,345	24,588,800	(37,165,648)	2.44%	Decrease
MCO	Moody's	$1,632,000	($21,120)	$1,129,440	48,000,000	0	2.34%	No Change
WMT	Wal-Mart Stores, Inc.	$1,194,464	$73,595	$1,032,915	19,944,300	0	1.71%	No Change
BUD	Anheuser Busch Cos. Inc.	$898,264	$38,213	$727,693	13,845,000	0	1.29%	No Change
AXP	American Express Co.	$893,546	($4,817,626)	$1,097,072	25,220,034	(126,390,666)	1.28%	Decrease
UNP	Union Pacific Corp.	$633,751	($38,652)	$686,118	8,906,000	0	0.91%	No Change
MTB	M & T Bank Corporation	$584,530	$110,850	$569,008	6,549,360	(165,700)	0.84%	Decrease
WPO	Washington Post Co.	$580,487	($433,538)	$393,650	1,042,615	(685,150)	0.83%	Decrease
NKE	Nike Inc.	$511,183	$55,703	$565,128	7,641,000	0	0.73%	No Change
USG	USG Corporation	$437,048	($67,777)	$205,037	17,072,192	0	0.63%	No Change
COST	Costco Wholesale Corp.	$341,142	($27,374)	$297,061	5,254,000	0	0.49%	No Change
KMX	Carmax Inc.	$258,217	($44,030)	$383,637	18,444,100	(2,855,900)	0.37%	Decrease
CMCSK	Comcast Corp	$236,640	$11,520	$210,720	12,000,000	0	0.34%	No Change
GE	General Electric Co.	$198,336	($9,256)	$127,947	7,777,900	0	0.28%	No Change
IR	Ingersoll-Rd Company LTD.	$175,674	($35,281)	$211,880	5,636,600	0	0.25%	No Change
BAC	Bank of America Corp.	$175,000	($42,217)	$69,800	5,000,000	(4,100,000)	0.25%	Decrease
ETN	Eaton Corporation	$163,411	$0	$230,224	2,908,700	0	0.23%	No Change
UNH	United Health Group Inc.	$161,986	($6,014)	$213,408	6,379,900	(20,100)	0.23%	Decrease
LOW	Lowes Companies Inc.	$153,985	$8,735	$131,820	6,500,000	(500,000)	0.22%	Decrease
STI	Sun Trusts Banks Inc.	$144,175	$28,105	$82,839	3,204,600	0	0.21%	No Change
NSC	Norfolk Southern Corp.	$127,984	$6,843	$110,297	1,933,000	0	0.18%	No Change
NRG	NRG Energy, Inc.	$123,750	$0	$114,950	5,000,000	0	0.18%	No Change
KO	Coca Cola	$115,067	($10,280,933)	$123,488	2,176,000	(197,824,000)	0.16%	Decrease
SNY	Sanofi Aventis	$111,253	($18,474)	$102,791	3,384,633	(519,300)	0.16%	Decrease
WBC	Wabco Holdings Inc.	$95,958	$0	$104,868	2,700,000	0	0.14%	No Change
HD	Home Depot Inc.	$95,793	($2,126)	$106,116	3,700,000	(481,000)	0.14%	Decrease
UPS	United Parcel Service Inc.	$89,882	$2,029	$95,328	1,429,200	0	0.13%	No Change
IRM	Iron Mountain Inc.	$82,315	($7,217)	$78,336	3,372,200	0	0.12%	No Change
GSK	GlaxoSmithKline	$65,646	($1,148)	$55,163	1,510,500	0	0.09%	No Change
GCI	Gannett Inc.	$58,299	($16,410)	$45,336	3,447,600	0	0.08%	No Change
TMK	Torchmark Corp.	$31,532	($134,088)	$28,083	527,279	(2,296,600)	0.05%	Decrease
CDCO	Comdisco Holding Co.	$14,466	($220)	$13,082	1,521,162	(16,704)	0.02%	Decrease

http://www.coattailinvestor.com/members/default.aspx

Risk - the most difficult to quantify element (II)

If you reflect on Buffett's approach, you realize that the risk isn't inherent in the stock's price, but rather on the clarity and consistency of a company's future prospects.

The more unpredictable (hard to understand) the company and its future, the greater the risk.

There is no way to easily quantify this kind of risk.

Generally, business risks are accounted for in the discount rate by making a conservative assumptions - a high discount, or hurdle, rate - to provide a margin of safety.