Play it Safe and Profit Big: The Benefits of Low-Risk Investing
An Investing Approach You Can't Afford to Ignore
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Hi Everyone,
The reason why so many investors lose money on the stock market is the prevailing misbelief that risk-taking is rewarded. From the financial press to investment advisors to finance classes at universities you hear the foolish assumption that only higher risk can lead to higher returns.
This couldn’t be further from the truth.
In fact, your results are largely determined by the type of stocks you buy. And the lower their risk characteristics are, the higher your return will be.
It all depends on how well you eliminate the risk of failure and how patient you are. By eliminating the risk of catastrophic loss and by focusing your investment selection criteria on risk, not reward, you can become a very successful investor.
Let's assume the worst scenario: A total loss. What’s the most obvious sign that protects us from a complete wipeout?
It’s consistency.
A company that’s producing consistent results year after year is unlikely to go bankrupt. You might buy it for a high price and experience a selloff, but you won’t suffer from a total loss.
“But how can you know that it will stay that way?”
While you can't know for sure, you can still make educated guesses by following the rules that apply to business valuation. For a company to constantly grow (even if it's slow) and increase shareholder value, it must have a competitive advantage (branding/awesome products/patent protection, etc.). Without one, a good performance over many years wouldn't be possible. And deteriorating fundamentals don’t appear overnight. In case of mismanagement, investors still have a few quarters to get out.
Here’s a previous article about some of the most consistent companies that have been in the business for decades:
Now, let’s look at 2 examples and use a low-risk framework:
Monster Beverage MNST 0.00%↑ and Celsius Holdings CELH 0.00%↑
Both are beverage producers, therefore a comparison is obvious. But which one has lower risk characteristics? Both stocks have been rising in recent years, but a rising share price means nothing as long as it’s not backed by fundamentals. Read more on this topic below:
Let’s start with Monster Beverages:
This company shows consistency. Revenues are rising year after year and most importantly the Revenues transform into Free Cash Flow (free cash flow is the cash left over after a company pays for its operating expenses), which can be used for stock buybacks for example.
If we look at the profitability ratios we also get a clear picture:
Profitability ratios indicate how efficiently a company generates profit and value for shareholders. Higher ratios are often more favorable than lower ratios, indicating success at converting revenue to profit. Investing in companies that show high consistency in those ratios lowers the risk of failure.
How does Celsius Holdings compare?
I think the numbers speak for themselves. The company is growing incredibly fast but fails to do this profitably.
“But why did the stock rise so much?”
Because Wall Street makes the same mistakes over and over again by focusing too much on rising revenue and ignoring how this converts into shareholder value.
The assumption is usually that the fundamentals will follow once the growth phase slows down. But why not wait until then? Why not invest in facts instead of fiction? Many great companies are in business for decades, but that doesn’t make them bad investments.
Final Thoughts
We have now determined which of those two stocks is an investable low-risk company. After figuring this out we need to find out if it’s a good investment (that’s the second part of risk analysis where valuation comes into play).
Taking a quick look at Monster’s multiples I would say that there are better alternatives out there when it comes to valuation.
But valuation is a bit more complicated and a topic for a separate article.
To sum it up:
Think of picking stocks like a sports coach picks his players for the game. When you select players for a match, who are you going to choose? The player who sometimes performs or the player who might not become a world record holder but still play at a constant level that you can count on. Which one is the lower-risk option for your team?
Learn to recognize risk and avoid it at all costs.
Until the next issue. 👋
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Disclaimer: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from my research. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.