Volatility is not the same as risk
Weekly 11 2025 + Top Five March
Volatility is not the same as risk
"The whole world is crazy. Stocks will drop 30%, then rise 20%, only to fall another 30%. That will be the pattern. If you can’t handle that, stay away from stocks."
This is a loose translation of a statement by Marc Faber, author of The Gloom Boom & Doom Report. I don’t always agree with him—far from it—but he makes a valid point here.
That quote is about ten years old now. Who would have thought that, in recent years, we’d experience a period where volatility—the ups and downs of stock prices—would hit a historic low, as measured by the VIX?
That unusually calm period has now ended. At the slightest hint of bad news, stock prices plunge 20% in an instant, while at other times, we see jumps of 5% or more.
That’s why I want to emphasize: risk and volatility are not the same thing.
I sometimes receive concerned emails from readers when a stock drops 20%. But a 20% decline doesn’t necessarily mean there was—or is—significant risk. In fact, after such a drop, our risk often decreases. I’ll explain why.
Keeping emotions in check is crucial in investing. According to Warren Buffett, this—not IQ—is the key to success. One way to manage emotions is by understanding the difference between risk and volatility.
Volatility refers to stock price movements, up and down. In investing, this is measured by the beta ratio:
A beta of 1 means the stock moves roughly in line with the market.
A beta above 1 means the stock moves more dramatically than the market.
A beta below 1 means the stock fluctuates less than the market.
Somewhere along the way, this concept got misinterpreted. Stocks with a beta above 1 are often labeled riskier than those with a beta of 0.5. That might seem logical—higher beta stocks tend to be more volatile. But does that really mean a stock with a beta of 2 is riskier than one with a beta of 0.5?
Consider these two stocks:
Stock A started the year at €10, surged three times to €20, dropped to €5, and finished at €16.
Stock B started at €10 and steadily climbed by €0.50 each month, ending at €16.
Which one is riskier?
The answer: Price movements tell us nothing about risk.
Risk isn’t about how much a stock fluctuates—it’s about the permanent loss of capital. In other words, risk only exists if a stock’s intrinsic value declines.
Now, let’s add another layer:
Stock A’s intrinsic value is €20.
Stock B’s intrinsic value is €8.
Which stock is actually less risky?
Stock A, which is currently trading at 80% of its intrinsic value? Or Stock B, which is priced at twice its intrinsic value?
And when Stock A briefly dropped to €5—just 25% of its intrinsic value—wasn’t it even less risky than it is now at €16?
Should we just ignore a 20% drop?
Absolutely not. It’s crucial to analyze why a stock is falling.
Is it just volatility?
Or is there a fundamental reason that has reduced its intrinsic value?
In reality, volatility is an investor’s best friend, while risk is the enemy.
We minimize risk through thorough analysis and a margin of safety.
We use volatility to our advantage.
If the market pushes a stock below its intrinsic value (including a margin of safety), we buy.
If a stock becomes overpriced, we sell.
Anyone who understands this principle will be far better equipped to handle market swings. And I can’t shake the feeling that those swings are only going to get bigger in the near future.
Articles and updates this week
This week, we received financial updates from Manitou and Somero Enterprises.
Manitou saw a striking price movement: initially, the stock surged, only to drop by 20% on the day of publication—a clear case of misplaced market expectations.
Somero Enterprises also declined after releasing its results. However, I still view it as a high-quality dividend stock with growth potential.
On Tuesday, we published the first part of the sixth lesson in our introductory series on value investing: The Language of Businesses.
There’s been a small change in the Top Five Buy-Worthy Stocks: Sipef is now trading above its purchase limit and has been replaced.