Frants Preis is managing director of Preis Investments.
By Frants Preis
Investing in the stock market often feels like riding a roller coaster. The ups and downs can be thrilling or terrifying, depending on your perspective. However, seasoned investors know that understanding the difference between risk and volatility is crucial for long-term success.
In investing, volatility refers to the short-term fluctuations in share prices, while risk is the potential for a permanent loss of capital.
If you’re a sailor on a ship, the waves (volatility) make your journey uncomfortable, but they aren’t necessarily dangerous. It’s the hidden reef beneath the surface (risk) that can sink the ship.
Take the example of Amazon. In the late 1990s and early 2000s, its share price was highly volatile. It experienced dramatic swings, with prices plummeting during the dot-com bubble burst. Many investors bailed out, unable to handle the volatility.
However, those who understood the company’s strong fundamentals and long-term potential held on to their investments. Fast forward to today, and those who stayed the course have seen exponential returns.
Volatility can be unnerving, but it often presents opportunities. Consider Warren Buffett’s famous advice: “Be fearful when others are greedy, and greedy when others are fearful.” During periods of high volatility, quality companies often become undervalued. Astute investors who can differentiate between temporary price swings and genuine risk can capitalise on these opportunities.
In contrast, true risk lies in factors like poor management, unsustainable business models or disruptive competition. For instance, Kodak was once a dominant player in photography but it failed to adapt to the digital revolution.
This was a true risk that led to its downfall. Investors who didn’t see this risk lost their investments permanently, despite possibly experiencing lower volatility at times.
Understanding this distinction is crucial for long-term equity investors. By focusing on the fundamentals of a company such as its competitive advantage, management quality, and financial health, investors can make informed decisions that minimise true risk. This approach allows them to ride out volatility without panic, focusing on the potential for long-term gains.
Frants Preis is managing director of Preis Investments.
BUSINESS REPORT