So you say you're an investor, and you want to buy a stock -- but first, you want to know how risky it will be to buy that stock? Well, I've got good news and bad news for you.
The good news is that the stock market is replete with financial data websites that can provide you with a rating on your investment of choice. The bad news is that not every stock's risk rating will be the same on every website, and it's hard to know exactly how the ratings differ without paying multiple fees to multiple websites -- or even then, how to know which rating is "right."
Answer these 25 questions correctly, and you can dial down your investment risk. Image source: Getty Images.
Many websites offer stock risk ratings, but each one defines risk differently when rating it. Most sites concentrate on rating the market volatility of a given stock as defined by what's known as its beta. Some go further, delving into the financials, measuring balance-sheet strength, and taking into account growth rates. A few even venture to run discounted cash flow analyses to arrive at a stock's present fair value based on expected future performance. Pretty much all of these sites charge a fee for access to their proprietary estimations of a stock's risk rating.
The very simplest and most commonly accepted rating for a stock's riskiness, however -- its beta -- can be found on many financial websites for free.
Rate it yourself
Of course, the problem with using beta as a measure of a stock's risk is this: Beta measures how much a given stock's price deviates from "normal" stock price movements. A high-beta stock could be one that falls steeply when the stock market merely stumbles, a stock that soars when the market just plods along, or both. It doesn't tell you much about whether the business behind the stock ticker is a good business, or a risky business.
That's why, at The Motley Fool, we prefer to go beyond beta when measuring a stock's risk rating -- and you can, too. We've developed a 25-question test of true-false questions that lets you decide for yourself if a stock is risky or sound. (And you can find all 25 questions right here, for free).
More than just a backward-looking review of a stock's price performance, we ask questions like:
- Is the company profitable? (Because profitable companies are less risky than money-losers.)
- Does it have a "recognizable" brand name? (Because no matter how many of your friends drink bottled water, Coca-Cola isn't going away anytime soon. And Coke sells its own water anyway.)
- Does the company face direct competition from stronger rivals? (Always a risky business.)
- And is it run by owner-operators with a big stake in the company's success or failure? (Because you want management to have skin in the game alongside you.)
Best of all, these are all questions about a stock's risk that you can answer yourself based on easily available public information -- no fees required.
Simply put, there's no need to rely on internet "experts" to spoon-feed you ratings on an investment, when you can determine a risk rating all on your own. Instead, take charge of your investments, read the financials yourself, and you can determine how likely a stock or fund is to make money for you in the future. That's really the least risky way to invest in the stock market.
