Risk management is included by smart investing. What ever investment you purchase like bond, stock, mutual funds, or other, there are three different risks involved they are valuation risk, business risk, force of sale risk.

Business risk: This risk is most familiar and understood easily. Business risk is potential for loss of value by mismanagement, competition and financial insolvency. There are many industries that are influenced to higher levels of business risk. The biggest protection system against business risk is the existence of franchise value. Companies which has obtained franchise value are able to increase prices to adjust for increased taxes, labor or material costs.

Valuation Risk: In order to confirm the purchase of the stock at sky high price, you have to be actually certain that the future growth prospects will raise your earnings yield to more impressive level than of the other investments at your disposal.

The business may actually be wonderful, the stock will decline significantly if it experiences a significant sales decrease in one quarter or does not open new locations as rapidly as it originally projected. This is a give back to our basic principle that an investor instead of asking that “ is a company XYZ a good investment” he should ask that “is company XYZ a good investment at this price”.

Force of sale risk: If you had bought shares of good companies like for example Hathaway, Coca-Cola, Berkshire, Gillette at a decent price in a year then had to sell the stock some time after in the year. Crash would have destroy you that occurred in a month. Your investment analysis may be correct but you appointed a time limit, you opened yourself.

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