How Risky Are Your Stocks?
Sure, you've heard that
stock investing is risky business, but do you know how much risk is in
Here are six checks you can use to find
out. Each check can add or subtract one point from a stock’s overall
risk score. You could find the needed data on many financial websites,
including Yahoo’s Key Statistic’s report. If you do want to use Yahoo,
get there by entering your stock’s ticker symbol on Yahoo Finance (finance.yahoo.com)
and then selecting
The more a firm is loaded down
with debt, the higher the risk. The “total debt/equity ratio” (D/E)
compares debt to shareholders equity (book value). A zero ratio means
no-debt and the higher the ratio, the higher the debt. Although D/E
ratios often run into double digits, in my view, anything above 0.5
equates to significant debt. Subtract one risk point for ratios of 0.1
or less and add one point for D/E ratios above 0.5.
Bigger is Better!
The larger the firm, the more likely it is to have the product
diversification, financial stability and experience to cope with
unexpected events. Use “market capitalization,” which is the value of
all outstanding shares, to measure company size. Market-caps above $10
billion define large-caps, which are the safest. Firms below $2 billion
are small-caps, the riskiest category. Add one risk point for
market-caps below $2 billion, and subtract one point for market-caps
above $10 billion.
Profitability measures how much cash shareholders must invest to produce
a dollar of earnings. At a minimum you want stocks profitable enough to
internally finance their growth. Otherwise, they must borrow or sell
more shares to fund expansion. The most popular reliability gauge,
“return on equity” or ROE, compares net income to shareholders equity.
The way the math works, a firm cannot internally fund annual earnings
growth faster than its ROE. For instance, an ROE of 10 tells you that
the firm cannot internally fund earnings growth faster than 10 percent.
Add one risk point for ROEs below 10% and subtract one risk point for
ROEs above 20%.
Follow the Money
Institutional ownership is the percentage of a company’s shares owned by
mutual funds, pension plans, etc. Values above 40 percent tell you that
these wired-in players like the stock. Add one risk point if
institutional ownership is less than 35% and subtract one point for
values above 60%.
Shorts Targeting Stock?
Short-sellers make money when stocks that they’ve shorted drop in value.
The “short percent of float” ratio measures the number of shares shorted
compared to the total shares available for trading (float). The higher
the ratio, the more a stock has been shorted. While short-sellers can be
wrong, high shorting activity signals risk. Add one risk point for short
ratios above 10%, and subtract one point for ratios below 5%.
Stocks often become overvalued when the market gets excited about their
growth prospects. But, eventually the glamour fades and the market
begins looking at valuation. Most analysts use the “forward
price/earnings ratio,” which is the share price compared to the next
fiscal year’s forecast earnings, to measure valuation. Add one risk
point for forward P/Es above 40, and subtract one point for forward P/Es
Using the Scores
Use these scores to compare stocks that you own or are evaluating. All
else equal, lower is better. Here are six stocks with perfect (minus
six) risk scores.
offers payroll, human resource, and benefits outsourcing services to
small- to medium-sized businesses.
Qualcomm (QCOM): produces wireless
communications semiconductor chips and licenses chip technology to
T. Rowe Price (TROW): investment
manager and mutual fund operator.
Skyworks Solutions (SWKS): produces
analog semiconductor chips used for wireless communications.
Tractor Supply (TSCO): operates
retail stores selling farming and ranching supplies.
operates a retail electronic payments network that supports banks
issuing VISA branded credit cards.
Unfortunately, picking stocks isn’t that simple. Many other factors
affect whether you’re going to make money owning a particular stock.
Consider the risk score as another tool for your analysis toolbox.