A principle of investing is accepting a certain level of risk for a proportional level of reward. For any potential investment, you can read through the risks that a company itself has identified in its annual report. But what about the bigger risks that exist outside of companies? If the world had to identify potential risks in an annual report, what would those risks be?
The closest thing to such an annual report is the World Economic Forum's "Global Risks" report, which surveys more than 1,000 experts. What do these experts believe are the biggest global threats?
The most likely risks
What are the top five most likely risks that the world faces?
- Severe income disparity
- Chronic fiscal imbalances
- Rising greenhouse gas emissions
- Water supply crises
- Mismanagement of population aging
We've already seen some consequences of all these hazards: Occupy protests, budget and sequestration fights, a squeamish insurance industry, droughts, and questions over Social Security, health care, and Japan's ability to sustain itself.
It even seems that many these "most likely" risks have actually already transpired, but we have yet to see how much we can mitigate the impacts. This actually presents opportunities for investors. The companies that can address the fallout of these problems could be some of the most rewarding investments in the near future.
Take rising greenhouse gas emissions. While other car companies work to boost their average fuel economy to the federally mandated 54.5 miles per gallon by 2025, electric-car maker Tesla (TSLA -2.79%) is already ahead of the game with the Model S, which gets a fuel economy equivalent of 89 miles per gallon. If Tesla proves itself, it could continue to make deals to license out its technology, as it did for Toyota's electric RAV4.
Or take population aging. A smaller working population will have to support a larger elderly population, and "the number of Americans afflicted with Alzheimer's disease will at least double, to 11 million, by mid-century," according to the "Global Risks" report. However, the right pharmaceuticals could give the elderly a higher quality of life. For Alzheimer's specifically, drug makers have had a difficult time coming up with effective solutions. But while Eli Lilly (LLY -0.24%) continues to work on its attempt, solanezumab, it also will be making money off recently approved imaging agent Amyvid, which helps detect patients who might be in the early stages of Alzheimer's progression.
The most impacting risks
Along with the most likely risks, experts also ranked what risks would have the most impact. The top five included:
- Major systemic financial failure
- Water supply crises
- Chronic fiscal imbalances
- Food shortage crises
- Diffusion of weapons of mass destruction
You'll notice that a few risks make both lists. Not only is it likely that we'll see water shortages and bankrupt governments, but both will have larger impacts than most other trends. Beyond filling up your bathtub and prepping a pantry for anarchy, how else can you prepare for these risks?
Look at how these affect your investments and decide whether your investments are preparing for these realities, as well. As governments cut programs, does one of your investments depend heavily on uncertain government revenue? As water shortages threaten food production, as even Nestle's CEO worries, do you own companies that can pass higher food costs on to customers or that won't be squeezed by a rise in crop prices?
For example, given that Lockheed Martin (LMT 0.87%) takes in more than 80% of its revenue from the federal government, is the company balance sheet strong enough to weather the nearly $500 billion in defense-spending cuts that sequestration threatens to make over the next decade?
Or will Chipotle (CMG -0.08%) be able to continue increasing profits while its food costs rise? Last quarter, higher beef prices helped push its food costs as a percentage of revenue up 1.3%, but profit rose nearly 7%. If Chipotle's brand allows it to raise prices without much pushback from consumers, the burrito chain could have a better strategic position that other quick-service food establishments.
A broad view of risk
Companies obviously don't advertise every possible risk, and experts can't predict every eventuality. However, as investors, we must take the best course of action based on what we know. The above are just a few of the possible futures, and if you have different take on the outcomes, please leave it in the comments below.
