Got A Stomach For Risk? Look For Quality First

Fundamental investors often only consider companies that make a “short list” on the merits of a few key quantitative metrics. Such metrics may include liquidity or solvency ratios such as the quick ratio or interest coverage ratio or valuation ratio or interest coverage ratio.

Alternatively, valuation metrics may be considered. These include the price to earnings multiple or price to book multiple to determine how richly or inexpensively a given stock may be priced.

Growth investors do much of the same, with a closer focus on how a given company’s revenues (and hopefully profits) grow over time. Aggressive investors seeking growth may find that on a fundamental basis, many of the companies with sky-high growth rates also carry astronomical valuations.

This reality reflects (in most cases) the long-term earnings potential of such companies, even if said outfits are not profitable at a given point in time, or are barely starting to turn a profit.

For those seeking higher leverage to such growth names, particularly in lights of the outperformance of such assets over the past decade and throughout this coronavirus pandemic, I’d encourage such investors to focus on forward earnings quality and stability one forecasts with respect to earnings growth over a long period of time.

The road may become bumpier for growth companies, and thus conducting a sensitivity analysis to see how a given growth stock might perform in a worst-case scenario can help reduce near- and long-term risk tied to volatility in such scenarios.

Invest wisely, my friends.