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Definition of risk

What I am going to discuss about risk in investing, there maybe many that will not agree with me. Everyone is entitled to their own definition of risk. This is just my two cents worth of sharing from my own research on "what is a considered a risky venture in investing".

Business-like investing reduces risk

Investing is most intelligent and less risky if it is made business like. What this means is to approach investing from a business point of view. An investor that recognises the importance of investing only in businesses with very certain excellent economics for the long term (at least 10 years) is putting his capital into a safe and performing company. This type of company will have their shareholders' interests in the long term and is also good at running their business therefore churning out high net earnings and also actively retain it's earnings to continue growing it's excellent business further. The longer an investor stays with such excellent businesses, the higher the rate of yearly compounded returns through the period of time. 

On the other hand, excellent businesses also suffer from temporary bad earnings period (e.g. during a recession). However, it is the certainty of the long term business economics that will ride the company through the bad period. A quarter of bad earnings may therefore mean nothing as compared to the company's long term business economics that is still intact. The company may be still protected by their economic moat (e.g. strong branding and consumer monopoly). Thus, it is still not risky to continue investing in such excellent businesses through the thick and thin.

Lower price reduces risk

Many people shun and some even scorn the bear markets because of falling equity prices. However, the intelligent investor knows that the price he pays determines his rate of returns. Pay less and one gets more. Pay more and one gets less. So, an intelligent buy is made at stock prices below the intrinsic worth of a company's share price. The safest way to invest is to invest at very low prices much lower than intrinsic worth of a company. One may argue that low price can get lower. One never knows the bottom. This is indeed true. However, when one has invested at a sufficiently low price than the intrinsic worth of a company, even lower prices is a welcomed bonus for the investor to add on to his holdings in a company. If the company was assessed to have excellent economics, a lower price makes even more attractive bargains to invest more in the same excellent company.

It is better to chase after low prices than high prices. The internet stocks bubble and crash in the stocks market is a recent testimony to the dangers of chasing after high prices in companies where their business economics is uncertain.

Short-term versus long-term

Stocks investing is risky in the short-term. Volatility in stock prices plus unpredictability in the sentiments of the stocks market in short-term can make riches as well as reduce one's capital to ashes. Riskiness comes from trying to predict the short-term fluctuations of the stocks market which can and do spring surprises often. On the other hand, if an investor has evaluated correctly the long term business economics of an excellent company and invest at below the intrinsic value of such company, he can look forward to certainty of high rates of compounded yearly returns on his capital through the years.

A simple illustration is that one has bought a vending machine selling popular brands of beverages. If one can secure the vending machine to be placed at a shopping centre with high traffic flow and pays a small rental price to the manager of shopping centre. If the vending machine sells lots of drinks per day and after deducting the costs to purchase the drinks from a distributor and also rental costs, one still pockets the daily profits and keeps doing this business for the long term, the returns from this investment is going to be very lucrative. Try buying the vending machine at low price and also securing a long term low purchase lease for the drinks from the distributor to sell at the vending machine, one will get very certain high rates of long term returns the longer one keeps selling the drinks from the machine. There is only minimal maintenence cost for the vending machine and it can operate 24 hours per day and 365 days in a year. This is a typical business with strong economics in it's favour.

Let's do a calculation. If the average daily net earnings is $20 from this vending machine business and work that out for a year and keep the business running for a full 20 years. One will make a total of $146,000 after 20 years. This is assuming the profit margin remains the same through the years. If someone comes along and wants to buy this whole business over for $50,000 now. I doubt one who is intelligent will want to sell out the business at such loss since this is a lucrative and consistent business that will churn out total earnings much higher than just $50,000 can buy for the lifetime of the business.

So, short-term profits may mean nothing compared to the strong long term economics of a business. An investor should cherish a gem (business with excellent long term economics) once it is bought at the right price. Such investment nature is not risky since it has gone through rigourous evaluation and determination of the total value of it's earnings it can churn out over a long term, and one only needs to pay less to have the rights to this earnings in the case of the second buyer who wants to purchase the vending machine business earlier.

Conclusion

1. Investing is less risky and most intelligent when it is made business like.

2. Price determines rate of returns. Pay less and get more.

3. It is the long term economics of an excellent business that will provide high rates of compounded returns to an investor. Stay long term with such companies to ride through the high rates of compounded returns that is lucrative and less risky than chasing after fluctuating stock prices.

<Everyone has his own defintion of risk and may not agree with me on my sharing. It is not my intention to create argument on this matter but to bring a fresh perspective to what is risk in stocks investing. Happy investing and all the best!>