Making rational investment decisions can be a long and intricate process. Thousands of companies have shares traded on major stock markets, and it's too much to expect to know everything you need to know about all of them, so you need to find a way to screen out the majority of them and find a manageable number of companies for future analysis. Once you've selected promising candidates, you have to gather information about the company itself, its competitors, the state of its industry, and the general economic conditions facing all businesses. After you have all the data you want, you have to figure out how to analyze that data to find the companies you want for your final investment choices.
But just when you think you have it all under control, just when you've found the stocks you want to stick with for the long term, life often seems to pick that moment to present you with something you'd never expected. Many people curse their bad luck and conclude that they're doomed to be poor investors when this happens to them. It's exactly these situations, however, that define the best investors and differentiate them from the rest.
Change is the one constant
Investing involves risk, and part of that risk is the fact that change is a constant factor that affects your investments. Businesses voluntarily assume risk in many different forms. The nature of the global economy practically requires large businesses to expose themselves to political risks involved in making foreign investments. When Bolivia chose to nationalize its oil and natural gas resources in May, for instance, oil companies around the world -- including ExxonMobil
Political risk isn't something that only happens in other countries. Often, elections determining the presidency or which party has control of Congress can have major impacts on the fortunes of entire industries. For example, after the uncertainty involved in the 2000 presidential election was resolved, defense stocks like Boeing
Change happens every day
Not all changes that affect your investments are cataclysmic events that threaten the survival of companies or entire industries. Consider, for instance, the rising price of oil over the past several years. To some degree, nearly all businesses are affected by higher energy costs, but some industries, such as transportation services and aluminum producers, are more dependent on energy costs than others. Companies like Southwest Airlines
Nearly all companies depend on supplies of raw materials to produce finished goods and services. Hershey Foods
Coping with change
As an investor, you should consider the effect of changing conditions on companies that you're considering for investment. Many companies are able to take advantage of futures markets and other hedging strategies to reduce their exposure to risk related to changing circumstances, and most of these companies will disclose their hedging practices in annual and quarterly reports. However, there will always be some types of change that companies can't anticipate.
During unexpected events, the value of strong and experienced leadership becomes apparent. Corporate leaders like Lee Iacocca of Chrysler
Finally, you should have an idea of what sorts of change you're unwilling to face as an investor before you make an investment. For instance, many investors categorically refuse to hold stocks that become the subject of SEC investigations or that have to restate their financial results because of accounting irregularities. Although this often leads to selling out after a substantial drop in a company's stock price, these investors avoid having to deal with the uncertainty involved in resolving these unusual problems. Furthermore, because such investigations divert attention from the primary functions of a business, it's reasonable to assume that business performance may well suffer while the investigations continue. On the other hand, you may anticipate certain types of change specifically to take advantage of the irrational ways other investors react.
Knowing how you respond to change is an important part of understanding your investing style. While you can control some of the effects that changing conditions have on your investments, you can't eliminate change entirely. With the right perspective, however, you can use change to your advantage.
Bill Mann and Tom Gardner assess the changing environment for smaller companies in their Hidden Gems newsletter, seeking stocks that will adapt well and reward their investors. Check it out for 30 days with no obligation.