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Chapter 2. Evaluating Risk > Summary - Pg. 14

Evaluating Risk 14 Faltering Growth/Creative Accounting Young companies exploiting emerging market opportunities often experience explosive growth in their early years. The market expects that growth to continue indefinitely and prices the firm's shares accordingly. Those early growth rates are unsustainable, and company management sometimes resorts to accounting shenanigans to maintain the illusion of growth when real growth slows. Even- tually the house of cards collapses, earnings fall short of expectations, and the stock price crumples. Chapter 12 describes how to spot red flags signaling slowing growth and the accounting shenani- gans that frequently mask faltering growth. Avoid stocks showing any red flags. High Expectations Unmet expectations lead to disappointment, and the market reacts by hammering the offending company's stock price. The higher the expectations, the more chance of disappointment. Conse- quently, high expectations equate to high risk. Chapter 4 describes how to calculate a Sentiment Index score based on analysts' buy/sell recommendations. Sentiment Index values of 9 or higher indicate risk, but high Sentiment Index scores alone are not a disqualifying factor. Summary Professionals always evaluate the risks intrinsic to a prospective stock purchase, and you should too. Be wary of investing in overvalued markets or in downtrending markets or sectors. There are thousands to choose from, so disqualify stocks with product allocation, litigation, earnings restate- ment, sector outlook, financial health, or creative accounting risks. The existence of any of the less serious risk factors makes a stock less desirable, so in terms of risk, "less is more."