A simple framework for picking low-risk stocks

A simple framework for picking low-risk stocks

Risk management is an essential component of investing. We can try to reduce the risk of permanent loss by investing in low-risk stocks.

Risk management is essential when building a stock portfolio. But it is impossible to remove risk completely. Instead, we should find ways to reduce risk in our investment portfolio, while maintaining a good chance for high returns.

With that in mind, here is a simple framework for picking low-risk stocks.

HOW TO FIND LOW-RISK BUSINESSES?

A low-risk business should have a strong balance sheet and an ability to consistently generate cash. Ideally, I look for companies with six qualities that should indicate it has a resilient business.

1. A MANAGEABLE DEBT LOAD AND LOW-INTEREST EXPENSES 

The company should be able to easily service its interest expense and to pay back its debts when they're due. The company should have both a low-interest coverage ratio (how easily it can pay back its interest expenses using profits or free cash flow) and a low debt-to-equity ratio.

2. CONSISTENT FREE CASH FLOW GENERATION

Read Also
5 must-haves in your personal finance checklist
money
5 must-haves in your personal finance checklist

Cash is the lifeblood of a company. It is what the company needs to pay its creditors and suppliers.

A company that is able to generate cash after paying off all its expenses and capital requirements (free cash flow to equity) is then able to reward shareholders through dividends, share buybacks, or reinvesting in the business.

3. PREDICTABLE AND RECURRING SALES

In order to generate cash consistently, a company needs recurring sales. A low-risk business should have recurring and fairly predictable revenue. This can come in the form of repetitive customer behaviour or long-term contracts. 

4. LOW CUSTOMER CONCENTRATION

The business should also have a varied pool of customers. A high customer concentration might cause wild fluctuations in sales and profits.

5. A DIVERSIFIED BUSINESS

Similarly, the business should ideally not rely on a single revenue source. A business that has multiple revenue streams is more resistant to technological changes disrupting a single core focus.

6. A LONG TRACK RECORD

Finally, a low-risk business should have a reasonably long track record of all the above qualities. The track record should ideally span years, if not, decades. Businesses that have such an admirable track record demonstrate resilience and management's adaptability to technological disruptions.

HOW TO FIND STOCKS THAT WILL NOT SUFFER FROM VALUATION COMPRESSION? 

Besides investing in stocks that have resilient businesses, we should also consider the risk of valuation-compression.

A valuation compression occurs when a company's market value declines permanently despite sustained earnings growth. This happens usually because the starting valuation is too high. If the purchase price is too steep, a good business may still end up becoming a bad investment.

The most common metrics that are used to value a stock are the earnings, cash flow, and book value.

Read Also
money
Your 3-step cheat sheet to prepare yourself for the next bear market

Another metric that I like to use is the enterprise value to EBITDA (earnings before interest, tax, depreciation, and amortisation). The metric is also known conveniently as EV-to-EBITDA.

The enterprise value, or EV, strips out the company's net cash from its market cap. Companies whose cash make up a large proportion of their market caps are prime acquisition targets. In addition, the net cash balance could also act as a support for which the company's market cap will likely not fall under.

I also look for companies whose earnings are likely to grow faster or longer than the market expects. This requires a reasonable amount of judgment. But stocks that eventually exhibit such sustained growth are unlikely to see a compression in their valuation.

THE GOOD INVESTORS' CONCLUSION 

If you've been avoiding stocks because of the fear of the risk of loss, don't.

Warren Buffett says that "risk comes from not knowing what you are doing."

If we pick stocks wisely, the risk of permanent loss becomes small. On top of investing in stocks that exhibit low-risk qualities, investors should also consider diversifying their portfolio. Diversification reduces the risk that a single mistake or an unforeseen circumstance will be detrimental to our overall portfolio.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.

homepage

trending

trending
    US Judge Frank Caprio, of TikTok fame, dies aged 88
    More Singaporeans find religion has 'considerable influence' in their lives: IPS study
    Tabletop, card games convention TableCon Quest 2025 triples in size as Bushiroad lands in Singapore
    Indonesia minister arrested as part of anti-graft probe, agency says
    MOE reveals timeline of Sengkang Green Primary bullying saga; pupil who sent death threats caned for subsequent incident
    Woman seeking man who helped to save 4-year-old son from drowning in hotel pool
    'Dreams don't expire': Desmond Tan buys first landed home, marks 39th birthday
    $218 release fee: Car park operator at Woodlands VEP centre criticised for clamping cars parked illegally
    Man finds missing bike after 3-hour search in Jurong, warns thief: 'I'll find you next time'
    From island-themed installations to festival villages: What to expect at Singapore Night Festival 2025
    'I saw the driver waving': SMRT bus captain who fought car fire near KKH says he couldn't ignore call for help
    Woman in China buys lottery while taking shelter from rain, wins over $170k

Singapore

Singapore
    • Nearly 80% of visitors to Johor in 2025 were from Singapore, says Malaysian official
    • $1,500 for a 10-minute ride? Grab blames 'temporary system issue' for price glitch
    • Only 4 out of 11 stalls are open: This Bukit Batok food court has been dubbed the 'saddest' in Singapore
    • 'Brave and selfless': SMRT praises bus captain for helping to fight car fire near KKH
    • 'I wasn't used to physical training': Art student on joining police Special Operations Command during NS
    • Alert from courier firm helps HSA uncover drugs, e-vaporisers with etomidate in raids
    • Who's sitting where: Singapore Parliament releases seating arrangements
    • Staff member found with active TB after screening at 2 pre-schools; no children diagnosed so far: CDA
    • FairPrice apologises after worm found in salmon bought from Bedok North outlet
    • Singapore indie cinema The Projector owes over $1.2m to creditors

Entertainment

Entertainment
    • 'I almost became a widow': Ada Choi discusses husband suffering heart attack in Singapore
    • Jack Neo uses AI to create SG60 song and music video that includes Lee Kuan Yew
    • Health alert: Jet Li undergoes surgery, Jackson Wang cancels fan-sign after getting food poisoning
    • K-pop girl group StayC prove they can do more than cute concepts at Singapore concert
    • Morgan Wallen reportedly not participating in 2026 Grammys
    • Tom Cruise almost broke his back, suffered 'separated' finger joints filming Mission: Impossible - The Final Reckoning
    • Wynonna Judd's daughter claims she covered up sexual abuse
    • Dawson's Creek cast to reunite for charity event in September

Lifestyle

Lifestyle
    • Indie darling The Projector announces immediate closure
    • 'Skibidi', 'delulu' and other social media words now found in Cambridge dictionary
    • From froyo to acai: Australian dessert chain Yo-Chi launches first international outlet in Singapore
    • Berry cute: Starbucks Singapore and Mofusand launching second collection on Aug 20
    • Cat A COE prices reach their highest point in almost 2 years in second bidding exercise for August 2025
    • The Projector bows out. And what's next for indie culture in Singapore
    • McDonald's teases BTS TinyTan Happy Meal, here's what we know
    • Largest Four Star clearance sale in Ang Mo Kio has $299 mattresses, up to 90% off sofas and more
    • 'We can't keep afloat anymore': Fluff Bakery to close after 12 years
    • We toured a rare part of Singapore where terrace houses are bigger than the semi-detached units

Digicult

Digicult
    • Singaporean Robert Sim receives one of Wikipedia's highest honours for his work on online platform
    • NDR2025: Govt to study new laws to protect kids from harmful, toxic content online
    • Apple Maps brings 3D landmarks and road-level realism to Singapore
    • The best AI tutor for O-level subjects: ChatGPT, Gemini or The Wise Otter?
    • Vivo X Fold5: A foldable contender with a few class-leading surprises
    • Here's everything in GPT-5 that's new and different than OpenAI's previous AI models
    • Australia regulator says YouTube, others 'turning a blind eye' to child abuse material
    • ZipZap car subscription service launches in Singapore
    • Sony RX1R III brings back the compact full-frame but not the Sony playbook
    • China's Premier Li proposes global AI co-operation organisation

Money

Money
    • Global markets face shaky week ahead as US pressure mounts on Ukraine
    • 6 best cashback credit cards in Singapore (August 2025)
    • Best bank offers in Singapore (August 2025): Limited-edition Stitch charms, 50% off flights and more
    • 9 best personal loans in Singapore with lowest interest rates (August 2025)
    • Best credit card promotions in Singapore (August 2025): Citibank, DBS, HSBC, UOB and more
    • Ninja Van cuts 12% of Singapore workforce after 2 rounds of layoffs in 2024
    • Goh Cheng Liang, Nippon Paint billionaire and richest Singaporean, dies aged 98
    • Singapore upgrades 2025 growth forecast but warns that outlook remains 'clouded by uncertainty'
    • StarHub buys rest of MyRepublic's broadband business in $105m deal; comes after Simba buys M1
    • Keppel to sell M1 unit's telco business to Simba for $1.43b

Latest

Latest
  • Zelenskiy says he wants 'strong' US reaction if Putin not ready to meet
  • Russia needs a nuclear shield update due to 'colossal threats', nuclear chief says
  • Daily roundup: Jack Neo uses AI to create SG60 song and music video that includes Lee Kuan Yew — and other top stories today
  • Thailand's Shinawatra dynasty faces triple court test that could upend politics
  • China's Tibet marks anniversary with songs, dances, reminders of Party's rule
  • Netanyahu escalates attack on Australia's Albanese as Jewish group urges calm
  • Member of Irish rap group Kneecap appears at UK court on terrorism charge
  • UN chief urges immediate Gaza ceasefire, warns of casualties from Israeli operation
  • Trump can end deportation protections for 60,000 immigrants, appeals court says

In Case You Missed It

In Case You Missed It
  • Van driver in Malaysia arrested for dropping off school kids while vehicle was still moving
  • Malaysian teachers caught vaping on school grounds may face fines, up to 2 years' jail
  • Shoelace to tie umbilical cord: Woman in Malaysia goes into labour by roadside, passing motorists help deliver baby
  • Man remanded after wielding knife, trying to snatch baby in Penang supermarket
  • 2 Singapore drivers allegedly detained in Legoland for offering illegal ride-hailing services; cars seized
  • Vers likely to be launched in next decade: Chee Hong Tat
  • Malaysia's border control agency gives ICA cake to mark SG60
  • Tourist in Hong Kong killed after cabby, 80, crashes into pillar outside hotel
  • 2 Malaysian men nabbed at Woodlands Checkpoint for allegedly smuggling drugs worth over $150k into Singapore
This website is best viewed using the latest versions of web browsers.