Can investing in stocks go wrong? Yes and here’s 5 ways how

Just how can investing in stocks go wrong? The stock market has dour days for sure, but surely only goes up in the wrong term. And the company’s slide deck and management all appear to be so good. So what could possibly go wrong? Unfortunately, quite a lot actually. You may get a clue if you read that one slide towards the end of the company presentation, or two pages amongst the 150 or so of a prospectus that allude to risks. Even though individual industries face their own risks, some are faced by all stocks, and we outline what could go wrong.

Can investing in stocks go wrong? Here are 5 ways in which it can

1. Broader market crash

Market crashes can and do happen. Although major bear markets (with falls in major indices of over 30%) tend not to happen more than once decade, it is not uncommon for bad days to happen every year – say a fall of 1-2% in the benchmark indice such as the ASX 200. Some companies’ shares may be able to perform even on the worst of days, but no company can escape a long-term downturn in the indices. Even Warren Buffett’s Berkshire Hathaway fell 40% between October 2008 and March 2009 as well as over 20% during both the Corona Crash and in the 3 months following Russia’s invasion of Ukraine. No doubt, many investors stayed for the tough times and were rewarded, but others may’ve bought at the top and sold as the bottom and lost money.

Berkshire Hathaway Class A shares (NYSE:BRK) share price chart, log scale (Source: TradingView)

2. A poor financial result/cash flow management

Regardless of market conditions, no stock can escape being punished for financial results, especially when such results are unexpected. When a company reports poor financial results, it can significantly impact its stock price, often causing it to decrease.

Investors view financial health as a key indicator of a company’s viability and potential for growth; thus, when earnings reports fall short of expectations, it can signal underlying problems. Such issues might include declining sales, rising costs, or operational inefficiencies. A dip in investor confidence can lead to a sell-off of shares, further driving down the stock price as the market adjusts to the new information indicating a potentially lower future cash flow for the company.

3. Management departure

The departure of long-term management, especially a pivotal CEO, can significantly impact a company’s stock, primarily due to the uncertainty and potential strategic shifts this change may invoke. Investors often view long-standing CEOs as stewards of a company’s culture and strategy, and their exit can lead to volatility in the stock as the market attempts to gauge the direction under new leadership.

The Steve Jobs effect

For example, Apple experienced a marked period of scepticism and stock fluctuation following the resignation of Steve Jobs in 2011. Similarly, Microsoft (NDQ:MSFT) saw a shift in investor sentiment and strategic direction after Steve Ballmer stepped down in 2014, though the subsequent CEO, Satya Nadella, managed to assuage market fears and lead the company’s shares to new heights. A bit closer to home, you could argue IGO (ASX:IGO) is in this category since Peter Bradford died and the company took over a year to find a successor, although there are other issues that arguably even he couldn’t have helped with (read: lithium prices). Not all transitions are smooth, and a company may indeed never be the same post a major managerial shift.

4. Competition

No stock’s management and IR department will tell you they are just a little fish in a big pond. Management will claim that they’ll have a great product that is superior to competitors, but maybe they don’t. Or perhaps, regardless of whether that is true or not, consumers just aren’t getting that message. New competitors can emerge with superior products and grab market share, just look at how Amazon (NDQ:AMZN) grabbed market share from brick and mortar retailers. Companies trying to do the same, may not necessarily succeed but burn substantial cash and shareholder hope in the process.

5. Run ins with the law

Encounters with regulators or involvement in legal cases can have substantial implications on investor confidence in stocks. Such run-ins often result in heightened scrutiny and can lead to fines, sanctions, or operational limitations. Moreover, they may indicate underlying problems within a company, such as weak compliance structures or management issues, which could materially impact future earnings and company reputation. This uncertainty and potential for financial loss can lead investors to reassess the risk profile of their investments, sometimes leading to sell-offs and a decrease in stock prices.

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