There are various risks in investing, and each sector and company present unique ones. But in this article, we look at several universal dangers which affect almost every stock regardless of industry.
1) Commodity Price Risk
Commodity price risk refers to the risk that fluctuating commodity prices pose to a business. Companies selling commodities often reap benefits when their price goes up while being hit when prices decrease; companies using commodities as inputs typically see opposite results, as do companies which use commodities themselves for input purposes – though even companies not directly involved with commodities may experience risk from commodities prices fluctuation.
As commodity prices increase, purchasers typically reduce spending – an outcome which impacts all aspects of the economy, including services.
2) Headline Risk
Headline risk refers to the danger that media coverage of a company could damage its business. With so much information floating through our global economy today, no company is immune from headline risk – for example, coverage of Fukushima Nuclear Crisis caused ripples among stocks involved with related businesses such as uranium mining firms and U.S. utilities with nuclear energy in their arsenals.
Even minor negative news can cause market reactions against companies and industries, often both. More widespread negative developments such as the obligation emergency in some eurozone nations in 2010-2011-can have profound repercussions for entire economies, not to mention stocks; with long-term ripples being felt throughout global economy.
3) Rating Risk
Rating risk occurs whenever a business is given a numerical target to either achieve or maintain. Each business has an essential credit rating number which impacts financing costs directly; public corporations also possess another key number known as their analyst’s rating, which matters just as much (if not more).
Changes to analysts ratings of stocks often have a strong psychological effect on the market and can trigger dramatic swings that go far beyond any valid reason for adjusting them.
4) Obsolescence Risk
Oldness risk refers to the possibility that a company’s business could soon go the way of dinosaurs. Remarkably, only around 100 businesses outlive their founders; those few that make it that far are unlikely to cling onto the same business practices used at inception. One potential out-dated quality risk is someone making similar products at reduced prices.
As global competition becomes more innovation-minded and the knowledge gap closes, outdated quality risks could increase over time.
5) Detection Risk
The detection risk represents the possibility that auditors, compliance programs, regulators and other authorities will miss an issue until it’s too late – be it management siphoning money out of their company, incorrectly declaring earnings or any other form of financial misdeeds that eventually surface as news stories. The market will bring its judgment soon enough.
Recognition risk means the damage to a company’s reputation could be difficult or impossible to repair; and it could even mean it never recovers completely in cases such as Enron, Bre-X Minerals, ZZZZ Best or Crazy Eddie’s where financial fraud was widespread.
6) Legislative Risk
Legislative risk refers to the unpredictable relationship between government and business, in particular the risk that government action will place restrictions on corporations or industries, thus impacting investors who hold shares of them negatively. Legislative risks vary in intensity according to industry but all have some presence.
In theory, public authorities serve as an important buffer between businesses and general society interests, providing relief when business activities threaten public welfare or are unwilling to self-regulate themselves. Unfortunately, in practice the public authority often over-legislates – increased visibility for itself as an institution as well as individual legislators’ publicity resulting in significant more legislative risk than truly necessary.