Individual Stocks: The Basics
What types of risks could I see if I own individual stocks?
Inherent to individual stock ownership is the concept of various types of risks that must be understood prior to acquiring individual stocks. Broad economic risk may occur and temporarily or permanently depress a stock’s price after you purchase it. Economic risk could be the effects on the economy and the stock investing community’s perception from such events as high unemployment, lower than expected exports, a drop in consumer purchases or confidence, an abrupt devaluation of a currency, or an unexpected increase in interest rates, among many others. Industry- or market-specific risks may also negatively affect the price of an individual stock, as perhaps a game-changing introduction of a new technology, or availability of cash for consumer credit, may negatively affect a stock’s price.
A change in government policies (political risk) may also cause a stock’s price to be depressed (for example, if the government decides to levy a tax or duty on the sale of a particular product). This may have both short- and long-term consequences. Materials and other input risks may influence the price of a stock, if the materials represent a rather notable component to the underlying product the company creates and sells. (Inputs are things used to make products, especially commodities like steel, copper, and petroleum.)
As prices for such inputs increase, profits of the company may fall. If profits fall, influencing the stock price, the value of the shares may fall. Technology risks may occur, and may have an immediate or delayed effect on the stock price. An example could well be the effect of the usage and proliferation of the Internet, and the effect this has had on industries such as the video rental market, music industry, and book publishing industry. How the target stock’s competitors develop and innovate may also affect the price of a stock, as a competitor may develop and apply a manufacturing or logistical methodology that makes it far more competitive, and therefore relatively more valuable to the market, perhaps affecting the price of stock.
Giant lawsuits may present legal risks, especially in such industries as finance, health, pharmaceuticals, and chemicals. An unforeseen lawsuit settlement may cause a company to file for bankruptcy protection, which would have an immediate effect on its share price. If a competitor to the target company attracts more competent management, or if the management of the target company is engaged in illegitimate activities, and less than competent management practices, these factors may also greatly influence the value of a stock.