How To Reduce Risk in Stock Markets

Leverage – Debt increases risk. The easiest way to reduce your risk is to not have leverage, especially margin leverage, in your portfolio. Margin leverage is one of the few ways that you can be correct in your investment analysis, and ultimately in the result, but still lose money. It’s not worth it.

The second easiest way to reduce your risk is to not invest in companies that have excessive leverage. Having excessive debt on a company’s balance sheet can lead to problems. Having excessive debt also limits opportunities. One of the key components to the “Balance sheet to income statement investing” that I advocate is the ability for a company to take on debt when they see an unusually attractive opportunity. Better to buy a company with little debt and a strong balance sheet that can use that strength to safely take advantage of those opportunities by adding a reasonable amount of debt. They can’t do it if they are already overleveraged.

risk in stock markets

Margin of safety – Let’s go to Michael Mauboussin quoting Warren Buffett, “We believe the best and most practical way to restate the margin of safety
concept is to think about discounts to expected value. The combination of probabilities and potential outcomes determine expected value.”

Says Buffett, “Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do. It’s imperfect, but that’s what it’s all about.”
A large margin of safety is helpful for many reasons. One, it gives you the opportunity for outsized gains. Two, it mitigates the effects of mistakes in analysis. And three, it helps protect against unknowable and unforeseen market and company-specific stresses.

Know your investment well – In order to know if you have a margin of safety, you must know your investment well enough to roughly determine its intrinsic value. Or, if you want to take the Mauboussin approach, determine the expected value. Clearly you must have the skillset to analyze a company. You also have to have the humility to recognize that the intrinsic value cannot be determined for some, perhaps most, companies. Other times the intrinsic value can be determined, just not by you. There is no shame in having a “too hard” pile. Mine is high.

I am attracted to companies where there are a low number of variables that are at least somewhat measurable. This is easier to do if you are relying on a company’s balance sheet rather than their income statement. It is also far easier for a company to manipulate their income statement, so this approach has the added benefit of higher predictability. Some investors believe that just because a company is small, it is more risky. This isn’t true. Those investors think that because a stock price moves more rapidly, a stock is more risky. They’re mistaken. Intelligently investing in smaller companies can dramatically reduce your risk. Most of the least risky companies I have invested in have been small. They were not risky specifically because of their low price relative to their actual value. They also were much easier to analyze.

Temperament – Here is where the self-awareness and Intellectual honesty fit in. This is a never-ending process and it is not easy. Nearly every investor, including the best, have succumbed to the market’s excitement and depression at one point. I don’t think it makes me a hippy to say that it is vital to protect your psychological wellbeing. Effective analysis consists of thousands of small judgments while researching a company. It’s a big risk if you can’t make those judgments with a clear head. This is also where ideology can blind you, and being blind as an investor is a dangerous thing. An investor always has to be mentally prepared to the idea that he is wrong, and if so, be willing to change his opinion.

Read the full insightful report from Arquitos Capital Management here

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Reliance Industries Plans Refinancing of Its $12 Billion Debt

Reliance Industries Ltd. plans to refinance a significant portion of about $12 billion of borrowings that mature over the next three years and may sell bonds to repay the debt, according to company executives with knowledge of the matter. India’s largest company by market value will repay some of the debt coming due, mostly bonds and interest, the officials said, asking not to be identified discussing confidential matters. Reliance’s repayments from 2018 through 2020 will be its biggest for any previous three-year period and include about $8.14 billion of term loans, $3.52 billion of bonds and a $300 million revolver loan, according to data compiled by Bloomberg. It also has about $1.65 billion of interest payments, the data show.

reliance

Reliance’s borrowings have ballooned over the past five years as the group invested in building its telecom business, a pet coke gasification unit and in expanding petrochemicals capacities. The plan to tap the bond market is part of a larger trend that’s seen Indian corporates choosing bonds over loans for the first time in at least a decade. One of the fastest economic growth rates in the world and Prime Minister Narendra Modi’s reforms have attracted global funds to India, reducing costs for issuers. “There is a lot of appetite among investors for Indian issuers,” said Raj Kothari, head of trading at Jay Capital Ltd. in London. “Reliance being the biggest company from India with solid finances, there would be no challenges for the company in refinancing its debt.”

Controlled by second-richest Asian Mukesh Ambani, Reliance has sufficient cash though it won’t use it to repay maturing debt as the company’s credit ratings and strong finances enable it to raise funds at competitive rates, the people said. A Reliance spokesman did not respond to an email seeking comment. S&P Global Ratings has a BBB+ score on Reliance’s long-term debt, two levels above the sovereign; while Moody’s has the company at Baa2, a notch above the Indian government. Reliance’s $1 billion 4.125 percent 2025 notes was quoted at 139 basis points over U.S. treasuries, the tightest spread since issuance, and lower than the average of 185 basis points on an index of Indian investment-grade debt compiled by Bank of America Merrill Lynch. The company earned about 94 billion rupees, or about a quarter of the company’s profit before tax, in the year ended March by investing its surplus cash in interest bank deposits, debt securities and other instruments, according to its annual report.

Reliance has yet to decide whether to raise the funds for refinancing through local- or foreign-currency bonds, according to the people. The company hasn’t decided on the timing of any new issuance or on the amount it plans to raise, though it will probably use several tranches as debt matures, they said. India’s second-largest oil refiner had outstanding debt of more than $31 billion as on June 30 and cash of about $11 billion. Reliance generated an operating profit of about 147 billion rupees ($2.3 billion) in the quarter ended June, which suggests that the figure could be around 588 billion rupees for this financial year. Reliance’s reported debt numbers may actually increase over the next two to three years due to planned investments of about 550 billion rupees in the current fiscal and a “significant payment” due for capital spending and deferred liabilities, Kotak Securities had said in a report last month.

  • Bloomberg

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