Company Risk (Investment) - Explained
What is Company Risk?
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What is Company Risk?
Risk is the possibility of an undesirable outcome. Investors in a company hope that a company will continue to perform as expected or more favorably. There is, however, a risk that the company will perform less favorably. This is known as company risk, specific risk, unsystemic risk, or diversifiable risk. There are numerous types of company risk that are relevant to the specific company. Some forms of risk might include:
- Financial Risk
- Reputational Risk
- Operational Risk
- Strategic Risk
- Regulatory Risk
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How Does Company Risk Work?
Financial Risk involves the risk associated with the company's finances. It can result from variations in the value of currency, sources of financing (debt or equity), financial holdings, revenue from operations, etc.
Reputational Risk regards the risk associated with negative events that can affect the performance of the company. For example, a negative public reaction to an advertisement can affect the companys brand value and goodwill.
Operational Risk concerns the risk associated with the delivery of the companys value proposition. This could include risk of losing talented employees, equipment malfunction, logistics problems, etc.
Strategic Risk concerns the possibility that the companys strategic orientation can lead to poor performance. This can result from changes in the competitive landscape or consumer sentiment.
Regulatory Risk concerns the possibility that changes in government or industry regulations or standards can affect company performance. For example, the changes in compliance and reporting standards can add additional costs to the company.
Legal Risk concerns the possibility that legal actions or company liability can disrupt performance. For example, a company may face tort actions by customers, contract actions from suppliers or buyers, regulatory actions by governmental bodies, or derivative actions from shareholders. A company investor is subject to company risk. Investors often seek to mitigate the risk associated with owning stock in one company by the following methods:
- Purchasing Uncorrelated Assets - This means holding stock in companies whose performance is not closely related.
- Hedging - Purchasing assets (or options on assets) that will perform favorably if the company investment performs unfavorably. This mitigates potential loss.