For many investors, risk and volatility means almost the same. Many analysts also use these terms interchangeably and ambiguously. But do you really know that there is a big difference between these two terms. One can destroy your wealth while other can multiply your wealth. Follow below to know the real difference:
Risk – It is the permanent loss of the capital due to permanent damage to underlying fundamentals of an asset class.
To make this understand easily, we have selected one classic case of Kingfisher Airlines. During the bull run of 2005-2007, the “king of good times” stock price skyrocketed to an all time high level of INR 335 in Dec 2007 from the price of INR 90 in June 2006. This implies a staggering return of 272% in just 1.5 years! And mind it, this stock performance was on the back of negative profits all through (From INR 20 crore loss for FY05 to INR 420 crore loss for FY17).
Good times ended badly when the market crash on the back of subprime crisis. Stock not just ever returned to its all time high, rather kept sliding due to poor business management and practices. Finally it got delisted from the stock exchanges in year 2015.
Anybody who had invested in the Kingfisher Airlines stock at higher prices and not booked profit has seen erosion of the invested capital. This is the real risk when there is no hope of recovery of invested capital ever in the future.
Many times risk occurs when investment is made for short term gains without understanding the business fundamentals or for speculative purposes as in futures and options.
Volatility – Normal ups and downs (read fluctuations) in the market driven by short term events and news-flows.
To make the point clear, we have selected Asian Paints as our subject of observation. During the market crisis in 2008, Asian paints declined from INR 128 in June 2008 to INR 70 in Mar 2009. A sharp fall of roughly 45% in just 9 months! Now let us look at its profitability during that period. The company reported consolidated profit of INR 398 crores in FY09, an YoY decline of only 3%.
These stock price corrections are normal in times of despondency. Let us see what a person missed who sold the stock fearing a further decline. The stock of Asian Paints currently trades at around INR 1,100. This is a staggering return of 16x in 7 years period, and that is without including hefty dividends!
Volatility results in prices moving above and below the fair value of the business. If there is nothing damaging to the overall business fundamentals in the long term, one should not be afraid of short term volatility in the stock price of any business. Rather volatility provides an opportunity for a wise investor to buy at prices lower than the value of the business and sell at prices much above the value of the business.
Many people, themselves are risk to their investments when they take any decision guided by emotions, without understanding the nature of the stock market which is volatile in the short term. One who understands volatility gains from it, one who doesn’t loses.
We hope, through this article we were able to clearly differentiate between risk and volatility. We would be happy to receive your feedback in the comment section below.