Buyer beware: the basic risks when investing

Caveat Emptor is the cute Latin term that is translated “Buyer beware.” This is legal mambo jambo to let you know that whatever you are about to buy, you are buying at your own risk. It is important to move our discussion of investing on capital markets to the uncomfortable subject of risk.

Risk is the flip side of investment no matter what investment you are talking about. Currently the ZSE is on a crazy bullish run (weird term that means share prices are going up driven by a rise in demand). This is most probably due to the fact that people are failing to access money from their bank accounts let alone to protect their hard earned income and savings from the erosion that we all can see.

From what happened in 2008 this strategy of buying shares could be a sound move because capital markets are near perfect markets where you can preserve value as long as you know what you are doing. However, the risks are there and unfortunately in an unstable economy like Zimbabwe currently the risks are on steroids. Here are a few basic risks to consider:

Risk of Loss

This is the most basic and inherent risk when investing in any way. If you are selling eggs for example you are not guaranteed that you will manage to sell your eggs at a profit. On capital markets too especially stock exchanges there is no guarantee that the share prices will go up after you buy or that they will at least remain where they were at the time of buying. Share prices can actually go down.

Economic Risk

Even in strong economies there are a lot of important factors that you as the investor has no control over which affect how companies perform on stock exchanges and how other financial instruments perform. In a weak economy the risk is larger and in an unpredictable economy like ours it’s even bigger.

Liquidation Risk

This is another term that we always see isn’t it? When a company gets into serious trouble it cannot recover from sometimes it’s only option is to sell all it has and disband. As the shareholder, you are entitled to a portion of the proceeds of such a sale proportionate to your level of shareholding and you can even get way more than you put in when you bought the shares.

However, there is catch: as a shareholder, you own the business so you are the last in line to get pennies when asserts are sold. The company’s lenders/creditors  (banks, suppliers, employees etc) have to get what they are owed first before you the owners of the business get anything out of it.If the company owes more than their asserts get sold for it means you are never getting paid, zvavharana.

Management Risk

Yes you hold shares and yes you are technically a part owner of the business but you don’t have much say on the day to day operations of ‘your’ company. Your involvement is mainly at Annual General Meetings or Extraordinary General Meetings which most of the times you actually have not much say because voting rights are weighted according to how many shareholding you have and in any case very few decisions are taken to these shareholder meetings. If the management of the company you invested in are not so great it adds to your risk, they may just grow the company into the ground and your investment goes up in smoke.

Special Zim Risk

We will look at this one more closely later. Right now I will just mention that the Zimbabwean situation is unique right now. You have to watch closely why people are rushing to invest, how much the share prices are increasing and how risky it becomes for you because every bubble will burst sooner or later.

People are buying because they don’t want to lose their savings and income as the money in bank accounts decreases in value by the day. Your homework becomes to assess whether the resulting increase in share prices is in real USD terms or it’s really the ‘transfer rate adjustment.’ Added to that you should also evaluate the real value of the different listed companies and then compare that to how much their trading at. If they are trading higher than they are worth don’t buy. Collecting garbage will not help you preserve value.

This looks like I have painted a gloomy picture right? It’s important to balance out optimism with a good look at risk. In future articles we will discuss how to reduce some of these risks and how to measure your risk appetite. For now I say again: learn about how the capital markets work, don’t take anybody’s word for it.