Making your first investment is exciting.
But before you dive in, it’s important to watch out for danger signs that could impact your investments.
A common pitfall for investors is focusing too heavily on the potential rewards while overlooking the risks involved.
Neglecting these risks can have serious consequences.
For example, a company might underperform, leading to lower revenue, reduced profits, and eventually less cash flow and dividends.
If this trend continues, your investment loses value as the share price falls.
Yet, if you manage risks well, investing can be financially rewarding.
Risks come in many forms, so let’s go through them together
Cyclical industries
Some industries experience boom-and-bust cycles that will impact every company within the sector.
Before you invest, it’s crucial to assess whether the company you’re considering is part of a cyclical industry and where it stands in the current cycle.
If you invest when the industry is at its peak, it could take years for the sector to recover and surpass its previous highs.
In the meantime, your investment might stagnate, resulting in opportunity costs as your money could have been better deployed elsewhere.
The semiconductor sector is a prime example of a cyclical industry.
In 2023, the global semiconductor market had a rough year, with sales dropping by 8.2% to $526.8 billion.
This decline marked the seventh downturn since 1990, averaging a slump every five years.
One company affected by this downturn is Micro-Mechanics (Holdings) (SGX: 5DD). The company, which manufactures precision tools for semiconductor fabrication, saw its revenue fall 18.7% year-on-year in fiscal 2023 (FY2023) ending 30 June, with net profit more than halving.
Micro-Mechanics didn’t fare much better in FY2024, with another 13.6% year-on-year decline in revenue and a nearly 18% year-on-year drop in net profit.
Another player in the semiconductor space, UMS Integration (SGX: 558), also struggled in 2023. UMS’ revenue tumbled by 19% year on year, and net profit plunged by 39% year on year.
These examples underscore the importance of understanding where a cyclical industry stands in its cycle.
Only by doing so can you better anticipate how companies in that sector might perform.
Economic risks
Another key risk is economic risk.
This risk impacts companies that are highly sensitive to the overall health of the economy, both globally and regionally.
Banks, for example, are among the most economically sensitive businesses.
They rely on making loans to businesses and individuals, earning fees from credit card spending, and offering wealth management services.
During tough economic times, banks face significant challenges.
A prolonged downturn can reduce lending activity and lead to higher levels of non-performing loans.
Take DBS Group (SGX: D05) as an example.
During the Great Financial Crisis of 2008-2009, DBS faced a sharp economic recession that caused its non-performing loan ratio to nearly double from 1.5% in 2008 to 2.9% in 2009.
To bolster its financial position, DBS conducted a rights issue in January 2009, raising S$4 billion to shore up its balance sheet.
Investors were offered one new share for every two existing shares, priced at S$4.93 each.
Said another way, even a strong bank like DBS had to issue new shares to strengthen its capital base.
This highlights the importance for investors to be prepared for such situations – either by having cash on hand to participate in a rights issue or by accepting the potential dilution of their shares.
If you had held onto those rights shares since 2009, you would now be significantly rewarded, as DBS shares recently hit an all-time high of S$43.02.
Risks related to REITs
REITs are often seen as a reliable way to earn regular income, making them a popular choice for income-focused investors.
However, it’s important to remember that REITs are essentially collections of real estate portfolios, and these portfolios need to be properly managed and tenanted.
If the properties are poorly managed or fail to attract tenants, the REIT’s distributions could decline over time.
The most fundamental risk for REITs is occupancy.
A high occupancy rate signals strong demand for a REIT’s properties, meaning they can easily attract tenants.
High-quality assets attract steady rental income and provide an opportunity for positive rental reversions where the REIT can raise rent when tenants renew their leases.
For example, as of 30 September 2024, Mapletree Industrial Trust (SGX: ME8U) boasts a solid occupancy rate of 92.9%, while Frasers Centrepoint Trust (SGX: J69U) enjoys an impressive 99.7%.
In their latest reporting, Mapletree Industrial Trust posted a positive rental reversion of 10.7%, while Frasers Centrepoint Trust saw a healthy 7.7% rental reversion for fiscal 2024.
But if a REIT’s occupancy rate starts to drop consistently, it’s a warning sign that needs closer attention.
Another inherent risk for REITs is interest rates.
REITs often rely on borrowing to fund their operations, hence rising interest rates can increase their financing costs, putting pressure on their distributable income and, ultimately, their ability to maintain attractive payouts to investors.
A recent example of this is Frasers Logistics & Commercial Trust (SGX: BUOU).
The REIT experienced a 40% year-on-year increase in finance costs for its latest fiscal year, which led to a 3.4% year-on-year decline in its distribution per unit, dropping to S$0.068.
By closely monitoring how REIT managers handle their portfolios, particularly in response to rising interest rates, investors can make more informed decisions about which REITs to add to their portfolios.
Sector-specific risks
Another type of risk is industry-specific risk, which can impact companies within particular sectors like telecommunications or cybersecurity.
A recent example is the major outage at Optus, a wholly-owned subsidiary of Singtel (SGX: Z74).
In November of last year, a widespread service disruption left half of Australia’s population without phone or internet access for most of the day.
As a result, Optus was fined A$12 million by the Australian Communications and Media Authority.
This outage was not the first major incident for Optus. In September 2022, the company was also hit by a cyberattack that compromised the personal data of over a million customers.
These incidents not only led to significant fines but also caused serious damage to Optus’s reputation as Australia’s second-largest telecom provider.
Another notable example is Crowdstrike (NASDAQ: CRWD), which experienced a major outage in July that caused 8.5 million Windows-based computers to crash.
The disruption led to widespread flight cancellations and impacted various industries, including banking, healthcare, and hospitality.
In response, Delta Airlines (NYSE: DAL) is suing Crowdstrike, claiming the company is responsible for US$500 million in losses.
The US Department of Transportation has also launched an investigation into the incident.
Both of these cases highlight the potential reputational and financial risks companies in sectors like telecommunications, cybersecurity, and technology can face.
Before investing in these industries, it’s crucial for investors to be aware of these risks and how they could affect their investments.
Get Smart: Risks are ever-present
Risks are an inherent part of investing and should always be the first thing you consider before committing your money.
That said, don’t let these risks deter you from investing altogether.
Instead, focus on managing them effectively – either by reducing your position size if you believe the risks are high or by steering clear of certain companies that may pose too much danger.
By staying mindful of both the risks and potential rewards, you’ll gain a more balanced perspective, which can ultimately lead to better investment outcomes over time.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: Royston Yang owns shares of DBS Group, Frasers Logistics & Commercial Trust, and Mapletree Industrial Trust.
