More often than not, investors tend to focus on finding the “next big winner” as opposed to protecting themselves from losses. But, it may actually be important for investors to focus on the downside as well. As the legendary investor Seth Klarman once wrote, “Avoiding loss should be the primary goal of every investor.” So, here are three things investors can do which may help lessen the risks they are taking on when investing in the stock market. 1. Put your ‘eggs’ in different baskets Diversification may sound like a complicated word, but what it really means is to spread…
More often than not, investors tend to focus on finding the “next big winner” as opposed to protecting themselves from losses.
But, it may actually be important for investors to focus on the downside as well. As the legendary investor Seth Klarman once wrote, “Avoiding loss should be the primary goal of every investor.” So, here are three things investors can do which may help lessen the risks they are taking on when investing in the stock market.
1. Put your ‘eggs’ in different baskets
Diversification may sound like a complicated word, but what it really means is to spread your capital so that you are not heavily exposed to any one particular asset. It’s important that investors at least consider the idea of diversification, or in other words, not putting all their eggs into one basket.
A good recent example is the broad sell-off in the shares of oil-related companies partly as a result of the drastic collapse in the price of the commodity (the price of oil has declined from over US$100 per barrel in mid-2014 to around US$30 today).
Through proper diversification, an investor may be able to lessen the impacts from declines in the shares of oil-related companies; over the past 12 months, while the rig-builder and property developer Keppel Corporation Limited (SGX: BN4) had declined by over 40%, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has fallen by ‘only’ 25%.
2. Invest for the long-term
Here at the Motley Fool, we advocate investing for the long-term. The reason is simple: Time in the market can be a huge advantage for an investor.
Investing for the long-term may also allow you to ride on the success of great businesses. An investor could have bought shares of healthcare services provider Raffles Medical Group Limited (SGX: R01) at S$1.51 at the last day of 2007, right before the Great Financial Crisis came into full swing in 2008 and 2009.
Despite having Raffles Medical Group’s shares fall over 60% to a low of around S$0.55 during the crisis, an investor who had held on since end-2007 will be able to sit on gains of 168% at Raffles Medical Group’s current price of S$4.05. It’s worth pointing out that the company’s profit had nearly doubled from S$36 million in 2007 to S$69 million over the 12 months ended 30 September 2015.
3. Digging into a company’s financials
It is important for investors to really dig into the financials of a company beyond just a few simple widely-used ratios. It is also important to follow the relevant industry trends. These can help investors play out various scenarios and determine how a company’s business may fare in each scenario.
Think about it this way. Let’s say you had filtered for stocks with low price-to-earnings (PE) ratios and a high dividend yield. One company that’s likely to pop out in the screen is offshore support vessels provider Nam Cheong Ltd (SGX: N4E). At its current share price of S$0.095, the company has an attractive price-to-earnings (PE) ratio and dividend yield of 6.8 and 15.8%, respectively.
But, if you dig deeper, you would have noticed that over the past few years, Nam Cheong has had trouble generating free cash flow and had taken on more debt. Furthermore, its business has links to the price of oil.
Such information can give you a more comprehensive understanding of the risks and rewards that can potentially come with a company. And, that’s something which a glance at the PE ratio or dividend yield can’t tell you.
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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 James Yeo doesn’t own shares in any companies mentioned.