by Noriyuki Morimoto
The risk of stock price fluctuation is an unavoidable risk that comes with investing in publicly traded stocks, but it is not an intrinsic risk. The intrinsic risk is the uncertainty surrounding the continuous growth of a company’s net business cash flow. The two risks are, of course, closely related, but at the same time clearly distinct.
Theoretically speaking, a stock price is the present value of a company’s expected net business cash flow. Therefore, the higher a company’s growth expectations are, the higher its stock price will be. However, since the present value is an estimate that stretches out to the distant future, even small changes in expectations can have a large impact on the stock price.
The fundamental risk of equity investment is the risk around changes in corporate value, but in the case of listed stocks, it is always accompanied by the risk of mere price fluctuation, which becomes a major disturbing factor.
A first-rate investor will not confuse the intrinsic risk of equity investment with the accompanying risk of stock price fluctuation, but neither will they ignore the latter. They participate in the sustainable growth of a company’s business cash flow, which is the original purpose of equity investment, while ensuring resilience against temporary price declines that happen from stock price fluctuation. In other words, they are committed to wise risk-taking related to the underlying business cash flow while appropriately managing the collateral risk of stock price fluctuation.
However, many ordinary investors do just the opposite: they lose sight of risk-taking in business cash flow amid the emotional ups and downs of stock price fluctuation, ending up losing money by selling where they should not.
Many people describe this issue as the reason we need long-term investment. However, this view suggests that the need for long-term investment is underscored by the significance of short-term stock price fluctuation as an essential element, whereas in fact, the essence of stock investment is to take risks related to business cash flow.
Rather, by resolving the problem into a time factor, it seems to have the detrimental effect of misleading people into believing that stock price fluctuations, which are merely an incidental risk inherent in listed stocks, are the essential risk-taking object of equity investment.
[Category /Investment Professional]
Chief Executive Officer, HC Asset Management Co.,Ltd. Noriyuki Morimoto founded HC Asset Management in November 2002. As a pioneer investment consultant in Japan, he established the investment consulting business of Watson Wyatt K.K. (now Willis Towers Watson) in 1990.