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 (NYSE:XOM), BP (NYSE:BP), and Petroleo Brasileiro (NYSE:PBR) -- had assets they believed were their private property taken away from them. Recent trade tensions between Canada and the United States over issues like cattle infected with mad cow disease and allegations of dumping practices by Canadian makers of forest products led to reciprocal duties and border closings that created huge uncertainty for producers on both sides of the border.
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 (NYSE:BA) and General Dynamics (NYSE:GD) initially responded favorably because of perceptions that a Bush win would be better for the defense industry than a Gore presidency. Just last weekend, legislation that clamped down on Internet gambling sites sent shares of online poker companies like Cryptologic (NASDAQ:CRYP) down sharply on fears that the domestic market for Internet gaming could practically cease to exist.
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 (NYSE:LUV) and Alcoa (NYSE:AA) consume huge amounts of energy in order to operate their businesses. In large part, the relative performance among the various airline companies has been determined by their ability to react to changing conditions and adapt successfully to their new business environment.
Nearly all companies depend on supplies of raw materials to produce finished goods and services. Hershey Foods (NYSE:HSY) depends on a steady flow of cocoa for its chocolate manufacturing, while problems with coffee supply can wreak havoc on companies like Peet's Coffee (NASDAQ:PEET).
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 (NYSE:DCX) became household names as a result of facing highly adverse conditions successfully with decisiveness and determination. While many investors focus only on the quantitative aspects of a particular business, the way company leaders interact with employees, suppliers, creditors, and other outside parties can make the difference between success and failure. Having a good management team is essential.
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.
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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.
Fool contributor Dan Caplinger tries to take life as it comes. He owns shares of BP. Cryptologic is a current Hidden Gems pick. You can count on the Fool's disclosure policy through thick and thin.
