Risk vs uncertainty: why one is a lot worse

Do you know the difference? It’s critical when investing in shares to work out whether a company has one or the other.

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Weighing up risk and uncertainty is everyday business for share investors.

But is there a difference, and what can you do about each?

Fortunately for The Motley Fool readers, SG Hiscock portfolio manager Hamish Tadgell this week settled this question once and for all.

“Risk is something you can price, based upon assumptions that you make,” he said in this week’s Ask A Fund Manager.

“Uncertainty is events that you can’t really price, because by its nature it’s uncertain and it [just] happens.”

For example, one risk is the chance of international and state borders opening up for travel. Investors considering buying Qantas Airways Limited (ASX: QAN) shares will be pricing this in when they decide how much to pay.

If you think border closures will last a couple of years, you will want a decent discount. While investors who are confident that travel will return to normal this year will be more confident about paying a few cents extra.

Uncertainty refers to unpredictable events that can’t be accurately or practically priced in.

COVID-19 is the prime example. This time last year no one would have known just a few weeks later economies would be shut down and share markets would be in freefall.

Tadgell told The Motley Fool that knowing the difference was critical to how his fund dealt with some crazy times in 2020.

“The question is how you deal with uncertainty – so our plan through COVID has been very much to look to buy strong, quality companies which have corrected, or which we think are looking more attractive,” he said.

“But also look to buy quality, cyclical stocks that are leveraged through a recovery, which we think will benefit. And then thirdly, look to sell out of things that we think are going to struggle to recover, or are going to be impacted from COVID permanently.”

Tadgell cited Aristocrat Leisure Limited (ASX: ALL) and SEEK Limited (ASX: SEK) as 2 stocks his team bought that were in the first category.

Somewhere in between risk and uncertainty

There are shades of grey in between though.

Fintech Tyro Payments Ltd (ASX: TYR)’s troubles this month could be interpreted as either.

The company’s card payment terminals were “bricked” en masse, forcing its small business clients to only accept cash from their customers or defect to a rival provider.

The problem could not be fixed remotely. So Tyro and its terminal supplier have had to physically collect defective devices and return them after repair.

Those who say that was “uncertainty” would argue that no one could have foreseen all those devices to suddenly crash out of action.

Then those who argue it was a manageable “risk”, like short seller Viceroy Research, would say that the event was inevitable because Tyro didn’t have sufficient business continuity processes in place.

Tyro’s shares have been in a trading halt since Viceroy’s report on Friday morning. The fintech’s management are currently busy working out a response — where we’ll find out whether they think it was a risk or uncertainty.

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Tony Yoo owns shares of Qantas Airways Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Tyro Payments. The Motley Fool Australia has recommended SEEK Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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