Risk vs Uncertainty

 

 

 

 

 

 

Jayant Pai | jayant@ppfas.com

Quick question: When was the last time you woke up in the morning and felt completely certain about the way your day would pan out? Sure, you may have aimed at accomplishing a series of tasks and also meticulously planned your path. Despite this, you tacitly knew and acknowledged that there was always the possibility that things may not turn out as planned. This, however, did not paralyse you and make you sit at home. 

The point I am making is that we live in an uncertain world. While some factors are within our control, there are others which are not. That is why I am puzzled to hear some market mavens advise stockmarket investors to desist from investing now and step in when things are certain.

Investors appear to be taking this advice rather seriously. We read reports in various media as to how retail investors are jettisoning stocks and fleeing to safer havens such as gold. This phenomenon is not restricted to India alone. The abiding global sentiment prevailing today is that stocks are ‘risky’ and should therefore be avoided. The grief-inducing headlines in various newspapers are further cementing this belief. Everyone says that they will invest when times are ‘more certain’.

But is ‘risk’ always positively correlated with ‘uncertainty’? The question may seem rhetorical but it is not.

While the term ‘risk’ may mean different things to different investors, to an equity investor it usually refers to the possibility of capital loss. But this loss could occur at any time, not only when the times are uncertain. Besides, the definition of ‘uncertainty’ itself is not cast in stone. Also, the occurrence of an event will not have the same impact on all. For instance, if Greece leaves the Eurozone later this year, it may adversely impact most Greek companies but may have no impact on most Indian companies. Similarly, a petrol price hike in India may cause an uproar over here but will not incense a driver in the USA.

Coming back to my earlier contention, it is worth pondering over the question as to when was the last time everything was ‘certain’. Uncertainty has always been a part of the economic and political landscape for the past few centuries, both here and abroad. Investors who wait for the last cloud to clear will be waiting forever.

I strongly believe that beyond a certain point, risk actually reduces as prices fall, even if the degree of uncertainty remains at an elevated level. I may be wrong, but I believe that we appear to be in that phase at present. Prices of many good stocks have fallen precipitously but the level of uncertainty remains stubbornly high. Today, valuations are attractive although they may not be compelling. However, waiting for that ‘most’ compelling valuation is a mug’s game. It is great if you get it but it is possible that the train will leave before you get on to it.

Will prices fall some more from here on? Sure, they may… but a temporary loss is not the same as a permanent loss. Investors should fear the latter much more.

Permanent capital loss is more likely to occur when you buy stocks when during exuberant times when everything looks rosy (Imagine purchasing DLF/Suzlon in December 2007 when the whole world was convinced about the India growth story) rather than buying during seemingly gloomy times. Think about it…

2 Comments

  1. Dear Mr.Pai,

    I can not agree with you more! As a value investor, one must understand that separating “uncertainty” from “risk” is essential for buying businesses worth dollar at fifty cents. One way to tackle uncertainty is to carry out scenario analysis and determine intrinsic value range for each scenario. If a business is available at a value where even under worst case scenario, down side is limited while one is exposed to huge upside on base case/best case scenario playing out, one must grab the opportunity with both the hands.

    In Indian market, I do feel there are such opportunities where business is surrounded by “uncertainties” that has created huge bargains. One such opportunity in my view is Piramal Healthcare where except “uncertainty” nothing will explain current valuation. However considering management integrity and competence, “risk” (i.e. permanenet loss of capital) is close to zero at current valuation.

    It would be interesting to know your views on the same.

    Best Regards
    Dhwanil Desai

  2. Dear Dhwanil,

    Thank you for reading and commenting…While I prefer not to comment on individual stocks, Piramal Healthcare does appear to be a good example of high ‘uncertainty’ but relatively low ‘risk’. Of course this comes with the caveat ‘While past performance is a good indicator of future performance, it is not fool-proof’.

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