Don’t let a catastrophe sneak into your portfolio
The rewards in the stock market can be vast – why else would we spend so much time on it? But the risks can often go overlooked as we dream of retiring down at the beach tomorrow. One risk I’d like to highlight is catastrophe risk.
Catastrophe risk quite simply is the risk that the company you’re analysing will encounter a circumstance in the future that drastically reduces their value. Examples of this include large impairments in profitability, bankruptcy, regulatory disruption or even a loss in competitive advantage. Understanding both ‘what you know’ and ‘what you don’t know’, goes a very long way to mitigating catastrophe risk.
Take, for example, the mining sector – whose revenue from operations is simply the ore price multiplied by volume. Perhaps through an analysis of the company and its capacity you can estimate the firm’s potential output and costs at a later date; however can you definitively estimate the future ore price? I know we at MIM can’t and hence we will largely stay away from this sector, avoiding catastrophes one at a time.
Companies we do take an interest in are those where catastrophe risk is minimised through a dominant market position, predictable recurring revenues, an unleveraged balance sheet or some set of other variables. Seek Limited (ASX: SEK) is one stock that naturally springs to mind, due to its market leading position, as does iSentia Group Limited (ASX: ISD), who have close to a monopoly on media monitoring and intelligence in Australia. Normal business risks apply to these stocks, but it becomes difficult to see their intrinsic values decline substantially in the near future.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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Pam Totolos
:
Dearest Roger,
as a manager of my son once said, “Its swings and roundabouts.”
I note that you have previously said by mid April 2015 there will be a correction in the market. The Dow is at an alltime high. “Irrational exhuburance ?”
Its quality, not quantity.
Top shelf stocks that produce yield over 7.75% grossed up.
The hunt for yield continues for mums and dad investors.
Kind regards,
Pam.
Andrew Legget
:
Completley agree with you Scott. By focusing on high quality companies you will likely reduce this risk by a great deal it does not mean you are completley protected. So as Scott said, you have to think not only about what you do know but consider and try to plug the gaps of what you don’t know.
May i also share my view that learning to spot the bad companies is as important as learning how to spot the good ones. Looking at what happened to previous scandals, catastrophes and other case studies in people losing a lot of money is a good place to start. That way you will develop your skills in spotting some man-made catastrophes.
Things like market crashes to a large degree are part of the natural cycle so it is hard for people to necessarily stop them in my opinion, they also help value investors with lots of opportunity.