IX. Risk Considerations

Introduction to Fundamental Stock Research

Risk is a key concept in investing, one that applies at many different levels. There is the risk of investing in an individual stock—based on factors such as the quality of the company and the stock’s volatility—but there is also the risk of getting into certain sectors or industries, or the risk of getting into the market at all based on economic conditions. In this chapter, we’ll introduce some important considerations for understanding the risk of a potential investment.

Market Cap

Market capitalization, known as market cap, measures the size of a company by multiplying the number of outstanding shares by the current price per share. A market cap above $10 billion is considered “large cap,” between $2B and $10B is considered “mid cap,” and anything with a market cap below $2B is considered “small cap.” For a variety of reasons, smaller companies tend to be more volatile and riskier, meaning you really want to do your homework before betting on a small company.

If you are just getting started with investing, it’s a good idea to start with larger companies. Not only do they tend to be less volatile, but they are also likely to be better known and more covered in the news. For added safety, you can start with blue chip stocks, which are very large, reputable companies that usually pay dividends. For example, the 30 stocks on the Dow Jones Industrial Average (DJIA) index are all considered blue chips. In Stock Rover, you can see these 30 stocks by going to Indices > DJIA in the Navigation panel.

Macro Environment

Is your stock in a friendly macro environment that will support its growth, or is it in a challenging macro environment that will work against even excellent companies? And is the stock’s sector or industry experiencing tailwinds or headwinds?

These are important questions. Picking a sector with positive momentum means you’ll be swimming with the current, while picking stocks in a declining sector means the opposite. You can still find excellent picks in poor-performing industries, but your task is that much harder. The same goes for the market as a whole—sometimes your best choice is to wait until conditions are more favorable for stock buying in general. For information on assessing the macroeconomic environment, see this blog post.

Your qualitative research will have already helped you understand a company’s competitive advantages and risks, many of which shed light on wider industry trends or macroeconomic concerns. Beyond that, it’s a good idea to keep a pulse on what is happening more broadly in the markets and economy. How is the economy faring at home and abroad? Is it a bull or a bear market? Which sectors are strong or weak right now? What is happening politically or with the cost of commodities that could affect certain sectors?

As usual, there is no formula to definitively these questions. Just try to have a clear idea of the main risks that your company faces, and why you think it will either benefit from the current macroeconomic climate or be able to overcome trends that are not in its favor.

Red Flags

When looking into individual companies, you already know you want to see increasing earnings, improving profitability, positive cash flow, manageable debt, et cetera. What about things you don’t want to see?

Obviously, you don’t want to see decreasing earnings, negative cash flow, spiraling debt, declining margins, or other quantitative indicators of problems, but what about qualitative issues? Here are a few potential vulnerabilities you’ll want to look out for as you learn about a company:

  1. Minimal product diversification. The company relies on a core product for most of its revenue. This means that earnings are at risk if something goes wrong with that product or demand shifts away from it.
  2. Concentrated geographic market. Similar to the above point, if the company is not geographically diversified, it is highly vulnerable to shifts in the region that it serves. Most large cap companies are geographically diversified.
  3. Concentrated customer market: Is the company overly dependent on a small number of customers? Is it overly dependent on sales to a certain industry? What is the outlook for those customers or industries?

None of these have to be deal-breakers, but they should raise questions about the sustainability of the demand for a company’s products, and about the company’s resilience if the market changes.


Practice these concepts with the following exercises. See this appendix for assistance.

  1. Explore a few different news sites for business and economic news, and check out Rover’s Weekly Market Brief for a summary of the week’s economic events. What do you learn that could be applicable to your investing?
  2. Chart all sectors against the S&P 500 over different time periods. Which sectors are performing the best?
  3. How do you feel about the sector and industry that your stock is in? Does it seem like a good place to be, or are there strong headwinds?
  4. Consider the red flags covered in this chapter. Does your stock match any of them? If so, does this lead you to any new concerns about the company? Or does it cause you to feel more positively about it? Why?

Next: Portfolio Construction

This guide was created in partnership with bivio, which provides online investment club accounting and hedge fund management services.