Why investing in the Canadian stock market is riskier than you think

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Canada – yes, boring, stable Canada – may be riskier than you think.

Our home and native land leads the world on some recent measures of investing hazard, according to an analysis by Aswath Damodaran, a professor of finance at New York University. Notably, Canada is now No. 1 when it comes to the percentage of money-losing companies on its public markets.

To be sure, this outburst of red ink reflects the large number of junior miners and small energy outfits on Canadian exchanges, as well as the more recent profusion of startup pot producers. It doesn’t mean that the country’s big banks or telecom providers have suddenly become dicey ventures.

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But comparing different parts of the global economy highlights how little time most of us give to thinking about risk. We focus on potential gains but often ignore the degree of peril we have to shoulder to earn that reward.

Investors may want to ponder the nature of risk more closely, especially now that the global economy appears to be slowing.

In a post on his Musings on Market blog, Prof. Damodaran looks at several ways to gauge how much risk you are taking on.

One method compares a stock’s highest price during the year with its lowest price, and expresses that range as a fraction of the sum of those extreme values. Do this for all the stocks in a market and you arrive at one measure of overall volatility.

Surprisingly, this HiLo measure shows Canada was, on average, the riskiest market in the world during 2018. The United States and Australia were also highly volatile. In comparison, Russia and Japan looked like bastions of stability.

A similar pattern is apparent if you calculate the standard deviation of stock prices, a measure of their typical spread. Canada topped the world chart on this measure last year, followed by Australia and New Zealand.

So should Canadians be concerned? Probably not, at least not so far as these particular measurements are concerned. Prof. Damodaran notes that both gauges of risk are limited. They punish markets with lots of trading and reward ones in which stocks change hands less frequently. They also make no distinction between upward movements in stock prices, which are good, and downward movements, which are bad.

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More worrisome are some more straightforward measurements of business risk. For instance, there is the disturbing fact that three-quarters of Canada’s listed companies reported negative net income in recent months. The only region with a similar level of money-losing businesses was Australia and New Zealand, where slightly less than two-thirds of listed businesses reported a loss.

Canada’s dismal showing isn’t necessarily reason for panic. The bleak patch for corporate profits in both Canada and Australia had a lot to do with the swoon in natural resource markets over the past year. Falling oil and metals prices combined to hammer the multitude of resource producers in both countries.

But the natural resource drag on these countries’ stock markets highlights the more fundamental issue of how industries differ. Around the world, real estate investment trusts, utilities, reinsurers, railways and banks are among the most stable industries in terms of stock-price variability, according to Prof. Damodaran’s calculations. Miners, biotech companies and energy producers are far riskier, with levels of volatility roughly three times higher than the most stable sectors.

As Prof. Damodaran notes, it is impossible for profit-seeking investors to avoid risk entirely. What is important is knowing which risks to embrace and which to avoid. One good starting point to recognize is that even developed markets like Canada can be surprisingly volatile and tied to single sectors. For anyone who wants to sleep well at night, diversification across a number of countries and industries makes a lot of sense.

Source: The Globe and Mail

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