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The Types of Risks We All Would Face With Shares

Equities, or what’s more popularly known as shares, are often considered as a risky asset class. But, what exactly is so risky about shares?

Let’s take a look into some of the major risks that all companies have to face in the world of business and how some of those risks can be mitigated.

Inflation and Currency risk

Inflation is always a big issue for everyone. It seems to be much more relevant nowadays as the cost of living seems to be constantly on the rise.

For companies, the issue of inflation can rear its ugly head in terms of a much higher cost of operation. For a company such as the full-service carrier Singapore Airlines (SGX: C6L), where its pricing power for its transport services is weaker, it might face diminishing profit margins as it’s likely that it would not be able to pass on cost increases to its customers.

The issue of currency risks is more significant for companies such as Noble Group (SGX: N21), which needs to import and export products in many different currencies. Given the wild swings last year in some currencies like the Indonesian rupiah and the Indian rupees, a whole year of profits earned by a company could be easily wiped out by unfavourable currency movements.

Companies can try to reduce currency risks through currency swaps or forwards and futures contracts. These financial instruments enable a company to fix the purchase and selling prices of its products before delivery to help ensure some profit on its trades.

Commodity price risks

The risk of adverse movements in the prices of commodities does not just affect companies in the commodity business. For instance, FJ Benjamin (SGX: F10), which is behind the famous local fashion brand Raoul, can be directly affected by cotton prices and indirectly affected by the price of oil price;  for the latter, as it increases, so would transportation costs for the company.

The risk of Mother Nature’s wrath

Lastly, as the 2011 Thailand floods and Japanese tsunami reminded us, Mother Nature can destroy anything when she’s angry. Even though companies can try to insure their properties, plants, equipment, and personnel against losses, it’s not hard to imagine how such companies can be crippled when they have to try and rebuild their operations again from scratch.

Foolish Summary

Investing in businesses through the stock market is certainly not a risk free venture. There are many things that are beyond the control of a company’s management team, much less us as outside investors. But, that shouldn’t mean we should be immobilised by the thought of all the different types of risks involved. Instead, we can diversify our investments and maybe even use these potential risks as a guide to analyse how good a company’s management is at mitigating such risks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.