"The dangers of life are infinite, and among them is safety." -- Goethe
When most kids are growing up, they usually like going to amusement parks and enjoy riding the roller coasters. Magic Mountain was my favorite, as the large drops always made up for standing in line for an hour for the opportunity to experience the three minutes of chills and thrills. As one gets older, there are other kinds of experiences which can take the place of a roller coaster. It might be joy riding in a car on a stretch of road where you can put the ‘pedal to the metal.’ Some consider things like skydiving, riding a helicopter, or in a fast jet as a way to scratch the itch of looking for an adrenaline rush. Each person is different in terms of what does it for them, but the common trait among all of these situations is that there is risk involved. The risk may be known, which is preferable, or not known. For example, you know when you ride in a car that going over 100 miles per hour can be dangerous. You would not know of the heightened risk if when driving so fast, a part fails, which is what happened to a driver in a Tesla recently. They were using autopilot, which failed, and a tragedy resulted. Obviously, the same thing can happen in a roller coaster, or a plane. Great, you say, but why does this matter in the realm of investing?
In finance, risk and return are usually linked together. It has long been thought that if one is searching for higher returns on owned assets, one must be prepared to bear additional risk. Conversely, if you want lower risks with what you own, fine, just understand you will probably wind up with smaller returns. In the stock market, there are a variety of measurements which are taught as ways to measure risk, including beta, which is market risk, and volatility, which can be thought of as the historical fluctuation of an asset (measured in standard deviation). Another thought is that the permanent loss of capital, usually by a company going bankrupt or having the earnings power of the business dramatically reduced, is the more important measure of risk. My own thinking has evolved on this over time, and I think the last one is the most important, but there is another risk with investing which is quite prominent. It is the risk of paying way too much for an asset which will not meet the growth projections in the current price. It is usually most applicable in highly priced assets, but can also occur on something which doesn’t grow at all. This week, investors decided that the data breach at Facebook and potential heavier regulatory scrutiny which is imminent is far too high at the current market price. The same thinking applied when President Trump was mentioned to be looking quite closely at how Amazon handles its tax obligations, whether correctly or incorrectly. Both of these situations are related to the risk of paying too high a price for a quality company. I have often avoided paying too much for fine companies because of this last risk. Almost all investors only have so much capital, and I believe you are trying to find the best situations for your money, and if you pay too much for assets, you may put yourself at quite a disadvantage. It will be interesting to see how things play out at Amazon and Facebook, but the risk issue, in whatever form, is one which is worth remembering.
On the macro front this week, revised fourth quarter GDP came in at 2.9%, besting the 2.7% expectation of most economists. Consumer spending was the highlight in the report. On the earnings front, Paychex, RedHat, and McCormicks all exceeded earnings estimates. The latter is a great example of a simple company which has a great business and has rewarded investors for many years. It is the kind of business, flavors and spices, which is dependable and consistent. Once in a while it gets valued too highly, or not high enough, which is quite seldom. Elsewhere, Wal-Mart is rumored to be talking to Humana about buying the entire entity. It is more evidence that the continued escalation of health care costs remains a problem even the largest companies are looking to solve.
Finally, with spring here, April quickly will bring the next version of earnings season. Estimates are high, and the banks will kick us off in a couple of weeks. Investors may be shifting the risk appetite to places like financials and energy, where the valuations are more reasonable and tailwinds like higher interest rates and a better economic environment will help. Still, risk is always present, and it is a matter of being quite aware of all that it entails.
Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of one's principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to one's risk tolerance, return objectives, liquidity needs, tax considerations, and one's overall financial situation. The fact that Yale Bock has earned the right to use the Chartered Financial Analyst in no way means or guarantees performance which will be superior to a market index.