Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earnings power through economic changes or deterioration in management.
Many in the investment world define risk in complicated mathematical terms. Many advisors and financial publications throw around words such as standard deviations, beta, alpha, and Sharpe ratio. As the mortgage meltdown and financial crisis of 2008 showed, sometimes risk needs to be looked at differently.
When examining investments in individual stocks for clients we take a common sense approach. We look at three interrelated sources of risk: valuation risk, business risk, and balance sheet risk.