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Equity: Equity Risks

What is equity risk? Well in one sense it is quite straightforward. Which of these two shares is the riskier?

Well, pretty obviously it is B. Its price is more volatile. Where does this kind of volatility come from?

As we have seen earlier in this module, a stock is a part ownership interest in a company. You may get dividends – which are payable at the discretion of management – and you may get capital appreciation in the form of a rising share price; but whether the payment of dividends is an option for management is directly dependent on the company's performance (its profitability); and a rising share price depends on the market’s assessment of the company’s performance.

In other words, the value of your investment rides on the company’s ability to be successful and profitable at whatever it is it does and the market’s ability to recognise that success. It sounds risky already doesn’t it?

The market perception part of this riskiness is a more tricky issue than the hard facts of whether a company is actually likely to be successful and profitable. Believe it or not, there are companies with a strong track record which the market consistently fails to value as such; and, even more unbelievably, companies with no track record at all, which the market places a very high value on.


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