It has been known that high returns have high risks. Keown, Martin, Petty and Scott, (2005) explain that in business, projects that have a high risk have very high returns. Only courageous investors invest in the stock market as it is very risky. The stock prices may increase or decrease at any time depending on the speculations in the market. If the share price rises, then the investor gets good returns for his money. Other investments, in bonds or in banks that pay fixed interest per annum, may offer very low returns, but one is assured of getting the money or returns at the end of the period. They are less risky but have very low returns.
Inflation is the rapid increase in the general price level of goods and services in a given economy. If the rate of inflation is very high, the cost of operation of any business increases. The raw materials of industrial products increase in price and this affects the prices of acquiring the products. These costs reduce the profit margins of the company or business implying very low returns. The costs of living increase, and therefore employees of various companies may demand salary increases to be able to buy the highly costly products. If a company increases the salaries, it results in very low levels of profits or returns due to high expenses incurred. The costs of borrowing increase due to the rising interest rates in the market. This implies that the funds borrowed for investing in projects become very costly to finance. As a result, the returns obtained are very low. Inflation can reduce the demand level of products by consumers; this affects the sales levels and, in the long run, reduces the returns from product sales in the market.
The term structure of interest rates is a curve that is drawn to show the relationships between the interest rates of a zero-coupon and its term to maturity. The spot rate of interest normally increases with the rise in the term to maturity but at a decreasing rate.
When measuring the expected rate of return of an individual investment, it is required that the internal rate of return should be used to assess the viability of investing in a given project. The Internal Rate of Return (IRR) is a discounting method that compares the Net Present Value (NPV) benefits with the cost of investment. The decision rule is to accept a project with a positive NPV and reject any investment with a negative NPV. The IRR must exceed the cost of investment for it to be considered to be viable. If the investment’s IRR is found to be less, then the project should not be taken. The individual investment must have a positive net present value to be viable. However, the IRR cannot be used in rating the mutually exclusive projects but only on the individual investment.
Risks can be measured by various methods like shortfall, Volatility and comfort and the value at risk method. The value at risk method measures the possibility of future portfolio losses remaining within a certain range (Hannon S., 2009, June 24). Diversification of investments helps reduce the riskiness of the investment. In case one investment fails, another investment can be relied upon. Investing all funds in one project is very risky since one does not have anywhere to rely on in case of losses. This is why a diversified portfolio is the best way of investing.
On the basis of the volatility of returns, Beta can be used to calculate the market risk. It measures the contribution of an individual asset to the portfolio of investment. It is the statistic that can be used to the risk of assets that one may demand to invest in a given portfolio. A portfolio beta uses the weighted average of the individual assets that form part of the portfolio.
Primoris Services Corporation has, over the years, invested wisely using the concepts of expected risks and rates of return. It provides services on pipelines, refineries, highways, bridges and marine facilities. It has consistently generated its returns on invested capital and equity which has exceeded all its competitors in aggregate. (Rolfe J., 2010). Primoris has generated very attractive returns beyond what its competitors have made. The company had gone public in July 2008 so as to beef up its capitalization policy to invest in even larger projects for higher returns. The company has invested shares in other companies and this led to the acquisition of the James Construction Group in 2009, thereby increasing its revenue base by 65%. (Rolfe J., 2010, September 27).
The company has diversified its investments geographically so as to reduce any macroeconomic vagaries that are region-specific. The company promises high returns in the future as can be seen by watchful investors. IT is also intending to increase its liquidity by issuing additional shares to the public. This will ensure high volumes being traded in the stock market to be able to provide more funds for investments.
Primoris uses the concept of diversification to be able to make high returns despite the current situation in the market. The banking crisis which had hit the US like a Tsunami affected many companies’ returns in the US. (EL-Khawas, M., 2008, December).The Company has still survived even after such a crisis, unlike its competitors. The competitors have not yet realized what the company has made over the years since its revenues are still high despite the challenges.
References
Arthur, J. K., John, D. M., William, P., & David, F. S., (2005). Financial Management: Principles and Applications (10th Edition).NJ: Pearson Prentice Hall.
El-Khawas, M. (2008). Review of US Financial Crisis and Latin America., Guyana Journal. Web.
Hannon, S. (2009). 5 Ways to Measure Investment Risk. Stock Trading To Go website.
Rolfe, J. (2010). Primoris Services: High return, Highly Cash Generative Company. Seeking Alpha Website.