Single Stocks—An Uncompensated Risk
Investing in single stocks can pay off big (early Apple), result in disaster (Enron), be a long-slow decline (GE), or be a roller coaster (most companies over time).
There’s a strong allure to picking stocks. It’s part of the American dream to win big and reap the rewards from taking risk. But individual stocks are risky in many ways:
Market Risk: This includes changes in market conditions, such as interest rates, foreign exchange rates, and stock market fluctuations.
Credit Risk: This is the risk of loss due to a debtor’s non-payment of a loan or other line of credit.
Liquidity Risk: This refers to the risk that an investment may not be easily sold or converted into cash without a substantial loss in value.
Operational Risk: This encompasses risks arising from the company’s day-to-day operations. It can include everything from internal processes, systems, and people to external events that impact the company’s ability to operate.
Compliance and Regulatory Risk: This involves risks associated with the need to comply with laws and regulations.
Strategic Risk: This is related to the management’s decisions regarding the strategic direction of the company. Poor strategic choices can lead to a loss of competitive advantage or market share.
Reputational Risk: This is the risk of damage to a firm’s reputation, which can result in loss of customers or decreased revenue.
Geopolitical and Country Risk: This involves risks associated with political changes or instability in a country, which can affect investments in that region.
Environmental, Social, and Governance (ESG) Risks: These risks are associated with environmental, social, and corporate governance factors that can affect a company’s performance and valuation.
Technological Risk: This relates to risks arising from new technology that can render a company’s products or services obsolete.
The ability to continuously monitor and evaluate not only the risks but strengths, opportunities and weaknesses of a single company is the full time job of teams of investment managers. It’s a herculean task for individual investors to perform the same due diligence.
It’s been said that the returns from single company stocks are an “uncompensated risk” because the risk cannot be reduced or eliminated by diversifying. While there could be outsized returns, there could also be also ruin without a backstop.
A common technique for those that want it both ways: diversification for the long game and the potential returns from picking winners is twofold:
- Keep the single stock portion of a portfolio to less than 10% of the overall portfolio. Be willing to lose it all.
- Ensure that after sound analysis, complete loss of the single stock portion doesn’t prohibit retirement goals.
Fights On!
Winged Wealth Management and Financial Planning LLC (WWMFP) is a registered investment advisor offering advisory services in the States of Florida, Texas, and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training.
This communication is for informational purposes only and is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This communication should not be relied upon as the sole factor in an investment making decision.
Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal the performance noted in this publication.
The information herein is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Winged Wealth Management and Financial Planning (referred to as “WWMFP”) disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose.
All opinions and estimates constitute WWMFP’s judgement as of the date of this communication and are subject to change without notice. WWMFP does not warrant that the information will be free from error. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall WWMFP be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided herein, even if WWMFP or a WWMFP authorized representative has been advised of the possibility of such damages. Information contained herein should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.
