One of the most important factors when making an investment decision is your risk. Although many savers overlook it, it is not an issue we should take lightly. Many investors have ended up losing a large amount of money due to not spending the time necessary to analyze the risk assumed in their operations. In this article we will see how to measure the risk of an investment in the stock market based on 4 key factors.
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- risk in value investing, is measured based on the possibility of permanent loss of invested capital.
You have to know that there is no easy and simple way to measure the risk of an investment. Risk cannot be measured precisely and millimeter. However, there are cases in which it can be seen much more clearly than in others. In the words of Benjamin Graham:
"It is not necessary to know the exact weight of a man to know if he is fat"
However, to give a brief orientation on how to measure the risk of an investment, there are 4 key factors that we must analyze. These are:
- Competitive ability
- Price paid
The biggest risk when investing in the stock market is us. The main problem investors have in Spain is they invest without the necessary capacity to do so. This poses a great risk to your investments for 2 reasons.
On the one hand, for lack of temperament. To win on the stock market it is necessarygo against the herd. As Buffett says:
"Be fearful when others are greedy and be greedy when others are fearful."
This, which is said soon, is not as easy as it seems.
On the other, there is the problem of lack of training. If you want to invest in the stock market, you will need to invest time and money in training first. I already tell you that it is not something easy to learn in a couple of hours. Of course, I also assure you that it is worth it. If you want a first class training, I encourage you to take a look at me Investor Club where you will learn to invest in the stock market, step by step and from scratch (take the opportunity, since you have a great discount and my total satisfaction guarantee).
It is also important to invest in companies that we are able to understand. To do this, it is necessary to assume our skills and our weaknesses. For example, I usually avoid sectors such as banking, insurance or biotechnology, since they are sectors that are too complex to assess for people who do not know them in depth.
Already within the analysis of the company itself, the first thing that we must look to analyze to determine the risk of a company is its financial health. The basis for the analysis of financial health is the study of the liquidity and solvency ratios and the debt ratios.
A great business can end up in the dust because of excessive indebtedness. This is usually seen in cyclical or unstable businesses that have not been able to prepare for moments of crisis during times of abundance. It is precisely what we are experiencing today in companies in some sectors such as energy or mining.
The second key factor that we must analyze is the ability of the company to compete profitably in the market. For this we must carry out a complete competitive analysis.
To determine the competitive capacity of a company we can start with an analysis of the sector. It is usually more interesting to invest in companies that compete in stable, even boring, sectors than in those that are listed in sectors whose future is difficult to predict.
It is also important to search for companies with sustainable competitive advantages, whatever your sector. Your presence will help them remain profitable and competitive in the long term.
This is a very brief summary of what we need to analyze. Personally, I analyze about 150 points before investing in a company.
Is it excessive? Can be.
However, I'd rather be cautious than end up losing money. 😉
The price paid
Finally, you have to be clear that, no matter how good a business is, it will only be an interesting investment if we buy it at a good price.
Therefore, count onsafety marginAdequate will be essential when selecting our investments. Adequate training will also be essential to allow us to analyze investments to calculate your intrinsic valueas accurately as possible.
In short, how do we know if an investment is risky?
Debt, competitive capacity and the price paid are key factors to analyze to determine the risk of an investment. This is the starting point, but it is necessary to go further if we want to determine the real risk of a company. The key will be to carry out a good financial analysis and, above all, a deep competitive analysis that allows us to know the company in depth.
As you can see, there are no shortcuts, although many try to convince you otherwise. If you are interested in learning to analyze companies in depth to invest in the most profitable and safe way in the long term, I encourage you to join the Investor Club, with all the step-by-step training to learn how to invest in the stock market and analyze investors like a professional.