Forum Archive Index - June 2001

["G Stolwyk" <stolwyk@wave.co.nz>]

 

Readers,

 

Please refer to the Disclaimer at the beginning of my previous post of June 28, 2001, time 22.24 hours: " LEARNING TO INVEST:.....(1).

 

4. Risk/Reward ratio.   Risk Tolerance.   Spreading of Risk.

 

By " risk ", I am referring to the chance of lower or higher share prices. There is upward risk if the chance of a rising share price due to certain factors, is greater than the downside risk.

  

The level of risk is difficult to quantify as there are two requisites involved:

All matters about the company are at present truly transparent.

Future real profitability, level of competition and all positives and negatives are known. In such a hypothetical case, the risk will approach zero.

 

Obviously, in the convoluted markets, the precise risk is impossible to predict: It is already difficult to interpret the announcements issued by a company, the quality of the accounts and to assess the level of experience and honesty of a new Board.

 

From now on, when I use the word " risk", it refers to a perceived risk which can lead to lower share prices. We can try to reduce this risk and hereby make the reward more certain, or, if we accept the increased risk, we want a much higher potential reward.

 

The perceived risk in investing in Bonds tends to be much lower than the risk associated with an investment in MMD! 

But one would expect a lower reward or return to the Bond investor.

 

Therefore, the higher the perceived risk level, the greater the need to reduce this to manageable levels and thus obtain a much greater reward!

 

" Investment Styles "- See item ( 1 ), to some extent differentiate perceived risk levels associated with these styles. In practice, I would have to be a Value Investor to be a Growth Investor. The latter will be interested in real growth and not " pseudo growth ".

 

Being a stock picker, my investments will show several perceived levels of growth and risks associated with my stocks.

 

When I invested in SKC, it was a good value stock as the price at that time @ $ 6 was too low, considering that this stock had excellent growth prospects and the dividend yield was high! I had reduced the risk by buying SKC at a perceived low price!

 

Ideally, a stock picker will apply all the necessary investment styles needed to produce an income. His / her risk tolerance can be medium if applied to the total investment. Those with little risk tolerance will deposit their cash in the Bank.

 

While I invest in any companies in some countries, another stock picker may select some stocks from one sector as he perhaps feels that he could " ride a cycle ", eg. he would have bought shares in some International coal stocks before the start of that particular cycle, two years ago.

 

 Such an investor may not sufficiently spread his risks by investing too much in one sector! 

 

I have QBE which was bought at the start of a new Insurance cyle with rising premiums; the risks are somewhat higher here than perceived for SKC. 

 

I own MMD but as the risk was high, I only made a small investment in this biotech stock.( I don't include this in my portfolio of stocks and keep it separate ).

 

I am a long term holder and if a new stock is selected I would look for a stock with a potential 70% increase over the next two years or higher still where the risk is higher.

 

These potentially large increases in share prices are needed to counteract future losses and lesser growth rates of the longer held stocks, and hence result in a good overall earning rate and income!

 

I need underpriced or undervalued stocks to do that!!

 

Spreading the risk and reducing it by investing in a number of various stocks, sectors and currencies, is a main issue when investing! 

 

Too much reduction of risk by buying too many stocks, can lead to overall less growth or income. I don't approve of that method! 

 

Surprisingly, the time spent on "looking at stocks", is not that great, once a certain level of expertise is achieved! After all, adding a new stock to the portfolio does not occur that often!

 

5. Investment Methods.

 

5.1 Weighting by countries.

One may see an article boasting that the company, fund or investor has outperformed a share index by x%. Many directors' bonuses are determined on that basis. The share index will have some poorly performing socks which drag down the index.

 

Outperformance of an index is a poor yardstick and it will be more appropriate to compare the performance with their peers of the sector! That may not always be possible in NZ. Other performance methods are also being used. 

 

Larger companies can be more attractive at times while the mid - cap. companies may stand out at other times. As interest rates decline, Banks can be popular and the converse may apply as the rates rise. The various currencies move and present additional risks.

 

The stock picker will identify the countries to invest in. One, Australia has about double the growth rate of NZ. Commentators have suggested that the world sees Australia and NZ as one market. That is not the way, I see it!

 

They don't know that Australia has many large interests in Europe and the US and a large international mining sector. Mind you, the effects of a continuing slowdown in the Far East must and will have an impact on Australia and NZ. 

 

Australian GDP growth rates are similar to those of the US and were much higher than those of the Euro-zone since about 1993. Source: " The Australian dollar.........", an important report from the ANZ ( On the Egoli site: " News and views " ). 

 

There is no precise advice as to how much investment should be in NZ, Aus., GB or Europe, the US and other countries.

 

Some investors play the more riskier countries and exchanges. My opinion is that no more than 25%  would be in NZ, 40 % in Australia and 35% in the remaining destinations. Taxation matters need to be looked into. 

 

If invested in a NZ or Australian fund with investments in say GB, then I would class it as such. At this stage, I have as yet not achieved these goals.

 

Gerry

( To be cont.).