How to minimise your risk in the stock markets

Stock markets will be highly volatile for some time to come. But that doesn't mean you should avoid investing – indeed, now is when some of the best bargains can be found. You just need to know what to look for on a company's balance sheet.

By MoneyWeek

published 28 January 2009

in Features

And when I go back to the house

I hear the woman's mouth

Preaching and a crying,

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Tell me that I'm lying 'bout a job

That I never could find

- The Silhouettes

Hopefully, the woman described in the Silhouettes' 1958 hit song, Get A Job would be a bit more understanding today. In 2009 America, it's downright difficult just to hang onto a job, never mind find a new one.

We saw more evidence of that today [22 January] when Microsoft (Nasdaq:MSFT), a company renowned for its stability, announced it will cut 5,000 jobs, in what is believed to be the first layoffs in the company's history. Shares tanked as a result.

Microsoft's news comes alongside a Labor Department report today that said there were 589,000 initial jobless claims this week, 54,000 more than projected. No surprise there. It seems the jobless numbers come in higher than expected every week.

On July 9, 2008, Republican politician Phil Gramm famously ignited the presidential campaign by declaring that the US economy was not in recession: "You've heard of mental depression; this is a mental recession."

While I disagree with Gramm's view, there is no doubt that fear plays a part. If people don't feel confident that they'll have a job next month, they're going to cut back on discretionary spending, which has a ripple effect on the economy. The kind of fear will continue to permeate the stock market, too. But despite what you might hear to the contrary, there is a way to combat it....

Cash is king

While the market is a forward-looking mechanism, I don't expect to see any kind of meaningful improvement for stocks until these massive rounds of layoffs decelerate at the very least.

Meantime, businesses and consumers alike will continue to employ the same tactic: Cutting back spending in order to conserve cash. And that's just what investors want to see from companies.

The 'cash is king' idea dominated proceedings at the JP Morgan Healthcare Conference that I attended in San Francisco last week. All the 6,000 institutional investors and venture capitalists could talk about was balance sheets. Companies with high cash and low debt were the darlings of the dance, while those who need to raise capital over the next year were about as popular as Caroline Kennedy at a meeting of the Rush Limbaugh fan club.

Here's what I took away from my discussions with these movers and shakers...

Pay attention to the 'risk-cash' relationship

Contrary to the overwhelming doom and gloom, there are actually companies that will attract institutional dollars in the coming months.

And while you'd think safer investments would be the popular choice, portfolio managers are willing to take on risk - just as long as it's not the risk of running out of the cash needed to operate the business.

This is similar to the approach I take in the Xcelerated Profits Report newsletter. I zero in on companies that have drugs in late-stage clinical trials. While there's a better chance of success at this stage (i.e. getting the drug approved by the FDA), these stocks obviously still have some risk to them. If the drug fails, the stock will fall. If the drug is successful, the share price should consequently rise significantly.

An investment tip for 2009

Right now, fund managers are still willing to accept this kind of risk, as long as the company has enough cash to remain a going concern. In fact, these kinds of investments are quite appealing because they offer the opportunity to do two things...

1. Chalk up significant gains.

2. Beat their industry benchmarks, which is often the basis for how fund managers are compensated.

A tip for 2009: Avoid balance sheet risk in 2009, but don't run scared from all risk. Remember... there will be some big winners in 2009, as there are a lot of investors sitting on the sidelines, just waiting to pile their money into the market at the slightest hint of positive news both for individual companies and on a macro scale, too. And we're going to need all the winners we can get in 2009.

This article was written by Marc Lichtenfeld, Senior Analyst & Healthcare Specialist, for the Smart Profits Report