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Business risk management is the identification, analysis, mitigation, and monitoring of threats to a company's overall well-being.
Business risks can be known or unforeseen, probable or unlikely, frequent or rare.
Even though publicly traded companies are wealthy, powerful, and staffed with some pretty smart people, they are still subject to considerable risk.
As an investor in these companies, you need to understand what risks the company you're analyzing is subject to.
Publicly traded companies all discuss risks, to a greater or less or degree.
As part of the SEC requirements, Risk Factors, are a topic in Form 10-K. In fact, risk is discussed in such a forthright manner, that you might learn of risks to the company you didn't even know existed.
After reading the Risk Factors section of a 10-K you'll understand that the company you're analyzing could experience losses from any number of events.
You might find comfort knowing that acknowledging risk is the first step toward managing risk.
Unfortunately the Risk Factors section typically lacks an abundance of information on how those risks are being mitigated.
The risks in the risk factor section, are typically from the outside environment.
These can be contrasted with internal risks - also known as operational risks.
Unless they are extremely ill-conceived, a single operational risk shouldn't threaten the company's existence.
In order to manage business risks, the company needs to hedge against them.
Your job, as an investor, is to understand the Risk Factors for your stock.
What is involved in risk management? Recognizing that a risk exists.
Observing the risk and the effects of risk reduction.
Do the executives of the company you're analyzing cultivate a culture of risk management? Do you feel like they have a grasp on the company's business risks? Do they acknowledge these risks when they speak publicly? Or, do they dodge the topic?
Simply listing Risk Factors in the 10-K isn't enough.
Those Risk Factors could've been conceived of a long time ago.
If the company has suffered losses from a business risk, determine how the company fared and if they learned any lessons.
What are the categories of risk? Risks can be classified in many different ways: Compliance.
Conflict .... Thus far, I've discussed two broad types of risk - business and operational.
Business risks include things such as recessions, sharp changes in commodity prices, pandemics, and government/political risks.
Technological failures, poor maintenance, lackluster accounting controls, and bad financial modeling are other examples of operational risk.
These risks threaten a company's ability to generate adequate cash flow to pay its obligations.
The fixed costs related to both of these types of leverage can translate into financial risk.
How do you assess risk when analyzing stocks? Most experts advise investors to appraise riskiness by reviewing measures such as alpha, beta, r-squared, standard deviation, Value at Risk, and the Sharpe Ratio.
An investor can expand on their risk analysis by reviewing the company's SEC Form 10-K. Specifically, the section Risk Factors.
All you can do is read and surmise how big you think a given risk is.
You can do your homework and learn more about the nature of a particular type of risk.
Ultimately you'll have to decide if the company's exposure to a given risk is greater than the reward it can offer you.
Let's take a look at the Risk Factors for three competitors in the Entertainment industry.
Each Risk Factor has been summarized for the sake of simplicity.
Admittedly, I've never scrutinized Risk Factors like this before.
There were certain Risk Factors that showed up for all three companies.
The business with the fewest Risk Factors, Comcast, still lists nineteen of them.
Disadvantages of risk management Difficult to calculate.
The company you're interested in investing in might be "Managing its risks." Is it doing so effectively, though?
Not to mention, the most appropriate way to mitigate the risk.
Use your own judgment about the company's ability to manage risks.
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Photo by Shipman Northcutt on Unsplash
