Value Investing – Principle #1: Risk Reduction (Lesson 6)
It seems to be a law of nature, inflexible and inexorable, that those who will not risk cannot win. – John Paul Jones
Everyday, each of us takes physical risks. The simple act of walking down a set of stairs carries risk of slipping and injuring oneself. Other acts include driving a vehicle, working with tools and cooking. Each of us minimizes the associated risks by taking precautions, behaving in a proper manner and just using common sense. Furthermore, we mitigate the results by utilizing insurance to repair the damage from the accident.
Financial risk is different than physical risk. Unlike physical acts performed frequently, financial investments are seldom transacted. It isn’t like you are going to buy Coca-Cola stock daily. Thus, it is much more difficult to contemplate best actions to reduce financial losses if the company goes south.
But with value investing, steps are taken to dramatically reduce potential financial losses. Risk associated with financial loss is addressed through three important practices. The first and best defense against losses are the type of stocks purchased. Only the best companies are considered with value investing. The first section below explains