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Safe investment

A. What type of stock would an investor purchase if he or she were primarily interested in a safe investment?

B. What do stockholders look for when reviewing and analyzing the income statement?

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What type of stock would an investor purchase if he or she were primarily interested in a safe investment?

In stocks income is earned either by way of dividend or capital gain. Generally investment in stock entails high risk. Risk is the uncertainty that you may not earn your expected return on your investments. For example, you may expect to earn 20% on your stock mutual fund every year. But your actual rate of return may be much lower.

Risk -return trade off
The risk-return trade-off requires that you accept more risk in exchange for the chance to earn a higher rate of return. If unwilling, you should expect to earn a lower return. Conservative investors, for example, are less willing to lose 10% of their investments in exchange for the chance to earn a higher rate of return. Aggressive investors, on the other hand, are willing to accept this risk in exchange for the chance to earn higher returns
Rate of return: An investor who is unwilling to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns. A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return

How to reduce risk while investing in stock

Using Beta
It measures a stock's volatility, the degree to which its price fluctuates in relation to the overall market. In other words, it gives a sense of the stock's market risk compared to the greater market. Beta is used also to compare a stock's market risk to that of other stocks. Investment analysts use the Greek letter 'à?' to represent beta.
A beta of 1 indicates that the security's price tends to move with the market. A beta greater than 1 indicates that the security's price tends to be more volatile than the market, and a beta less than 1 means it tends to be less volatile than the market. Many utility stocks have a beta of less than 1, and, conversely, many high-tech Nasdaq-listed stocks have a beta greater than 1.
Essentially, beta expresses the fundamental tradeoff between minimizing risk and maximizing return. Let's give an illustration. Say a company has a beta of 2. This means it is two times as volatile as the overall market. Let's say we expect the market to provide a return of 10% on an investment. We would expect the company to return 20%. On the other hand, if the market were to decline and provide a return of -6%, investors in that company could expect a return of -12% (a loss of 12%). If a stock had a beta of 0.5, we would expect it to be half as volatile as the market: a market return of 10% would mean a 5% gain for the company.
Implication on Portfolio
Hence, inclusion of relatively low beta stock will not entirely remove but it will reduce the risk. As low beta suggest that the stock is less correlated to the movement of market. Therefore it is a good hedge in downside. It will not fall as rapidly as the market. On the other hand the beta with 1.4 will fall rapidly more than the market in the event of decline.

Thus the investor should prefer those stocks which are having beta less than one.

Using Standard Deviation

These are the most familiar measurements of dispersion. Variance is the arithmetic mean (average) of the square of the difference between the value of an observation and the ...

Solution Summary

This discusses the concepts related to safe investment

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