I have talked about the importance of looking out for investment risks, and also wrote about how to incorporate a stock’s risks in a properly structured investment thesis.
Through a short series of articles, I would like to list six major types of investment risks, and each major type shall be elaborated on within an article. The six types are: (i) Management; (ii) Industry and Competitive Moat; (iii) Political; (iv) Economic; (v) Social; and (vi) Legal/Regulatory.
In previous articles, I had discussed Management risks, Industry and Competitive Moat risks, and Political risks. They can be found here, here, and here. In this article, let’s continue with a discussion on the economic risks affecting a company.
Look at the GDP (gross domestic product) growth history of the country in which the company is located. Are there signs that things are slowing down, or is the economy chugging along with no immediate issues? This is an important factor to consider as GDP is a good indicator of economic growth – if a country’s economy in not doing well, then the company domiciled within may also suffer alongside.
Inflation relates to the general increase in the prices of goods and services within a country, and it impacts consumer spending habits as higher prices generally dampens spending. Hyperinflation is a severe case of inflation where the value of money erodes rapidly – or put another way, the prices of goods and services are skyrocketing. Social unrest and widespread dissatisfaction often results from hyperinflation.
Be wary if a country has ever experienced hyperinflation as it may indicate a problem with its political and/or economic landscape.
General outlook for businesses
For businesses operating within a country, what is their general outlook and prospects? Find out whether companies are generally doing well, or struggling to grow. Some businesses may have to grapple with persistent issues such as policies which are not clearly defined or high taxes.
When a large swath of businesses in a country start facing a bleaker outlook, it may be an alarm that business conditions are challenging or deteriorating.
Other economic indicators
As investors, we can also look to other economic indicators other than GDP to determine the health of a country’s economy. We can look at the following: CPI (consumer price index), PPI (producer price index), and BP (balance of Payments). CPI is a measure of inflation within a country, PPI measures changes in average selling prices from the producers’ perspective, and BP measures the difference between the total value of payments flowing in and out of a country.
Finally, we should assess if a country’s exchange rate is stable, appreciating, or depreciating against other major currencies. If the economy is stable and doing well, then the currency should also remain stable or even appreciate. A rapidly depreciating currency could be a sign of fund outflows from a country, and could signal potential trouble brewing within the country – that’s typically bad news for locally domiciled companies.
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