Market risk

First there is background economic risk – the uncertainty of economic growth levels, inflation, interest rates, foreign exchange rates, import-export prices etc… 

This is often referred to as market risk. It is going to be there when you invest in any stock. But some companies will be more vulnerable to market risk than others. A high exchange rate, for example, will hit Electronic and Electrical Equipment manufacturers who target export markets, more than Food Retailers who target the domestic market, because a high exchange rate will make those electrical goods more expensive in foreign markets.

But it is not conclusive. A really efficient company in the electronics sector may suffer less than an inefficient food retailer. 

Industry risk relates to uncertainties caused by particular features of the industry sector in which a company operates.

These risks can vary dramatically. New technologies, for example, are always going to expose investors to higher uncertainty of future returns than the market average – because of the inherent uncertainty of their new products and new markets - and they will certainly be more uncertain than food retailers. (Food will never go out of fashion).

So industry risks can be identified and differentiated on a scale from low to high, relative to the market average. As investors need rewarding for taking on higher risk, we can expect that all stocks in the technology sector will offer higher returns than stocks in food retailing – but those returns are less likely to appear than the lower, more certain returns in foods. 

Company risk

Finally, there is company-specific risk. 

Each company – each stock – will deal with its sector risks and background economic (market) risk in its own way; and the way that each company turns threats into opportunities and efficiently exploits those opportunities will be decisive in generating shareholder returns.

Of course, some companies will underperform relative to their peers. And when they do, it is for company specific reasons.

When you are going about picking stocks to go in your portfolio, you need to consider all of these factors and not just in terms of trying to pick successful companies. 

Combining the different risk profiles of different stocks or sectors (diversifying) can help reduce the overall risk of your portfolio. You can see how in our 'Investing module'. But for now let's get a better idea of the nature of sector and market risk relationships.