Make more money investing by avoiding these 5 risks

Serious risks still faced by Bellamy's Australia Ltd (ASX:BAL) and Santos Ltd (ASX:STO).

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

It feels like there has been a wave of surprise profit downgrades recently.

This week it was shares in GBST Holdings Limited (ASX:GBT) and OFX Group Ltd (ASX:OFX) which plunged after disappointing pre-earnings season updates.

Many of the companies are blaming the impact of Brexit and the weakening UK pound, a risk that few people predicted. But it raises an important point I think a lot of investors miss: stop focusing on how much a company could go up, and put your energy into understanding what could go wrong.

Legendary investor Howard Marks even uses this view of risk as the mantra of his investment company Oaktree Capital:

'If we avoid the losers the winners take care of themselves'.

Because many of the risks we face when investing are outside of our control, Ian Schapiro, one of Oaktree Capital's portfolio managers, says there are five risks he won't go near:

1. Commodity risk

Companies involved in producing and selling commodities have far less control over the price they receive for their products, so risk is a much larger part of the investment.

Pricing can be hedged somewhat with contracts and derivative options, but even then companies get caught out. Energy producer Santos Ltd (ASX: STO) is a classic example, getting caught out by falling oil prices.

2. Turnaround risk

They may look cheap, but companies that need 'turning around' are likely to have already suffered brand damage and lost customer good will. These companies can underperform for years.

I think Bellamy's Australia Ltd (ASX: BAL) could be at risk of this as the company publicly brawls with its shareholders.

Focus instead on successful companies with leading market positions, says Schapiro.

3. Technology/start-up risk

Start-ups are exciting and often have big potential. Many start-ups prey on that hype to list on the stock market to help them grow.

But burning cash to achieve revenue growth automatically reduces room for error and makes valuation harder, so risks are much higher.

4. Returns based on financial leverage

It's much cheaper for a company to borrow money as debt than issuing equity to investors who demand higher returns. Debt is also a great way to amplify returns to shareholders.

However the illusion can be quickly shattered if market conditions change, and large volumes of debt leaves a company vulnerable and inflexible.

5. Public policy risk

Diagnostic imaging company Capitol Health Ltd (ASX: CAJ) relied extensively on government rebates to drive revenue, while operating with a high proportion of fixed costs. Profitability came crashing down when Medicare got put under review and shares plummeted almost 90% from their highs in 2015.

Foolish takeaway

Beyond these risks, Ian Schapiro points to three easy ways to improve your odds of success: understand the company; understand the management; and seek opinions which conflict with your own.

Once you've got your head around the risk, the strong economic engine underlying great companies will take care of the upside for years to come.

If you learn only one thing about investing today, make it this.

Motley Fool contributor Regan Pearson has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »