Reviewed by Somer Anderson

Risk Overview

No debt obligation, whether U.S. government or corporate, is free of all risk. However, U.S. Treasuries of all maturities have long been considered safe from the risk of payment default.

That’s because they are backed by the full faith and credit of the U.S. government. Thus, due to the stability of the U.S. government, investors believe that the principal and interest amounts owed on the money that they loan the government when they buy its bonds (and notes and bills) will always be paid.

In addition, Treasuries are extremely liquid, meaning they’re easy to buy and sell. The secondary market in Treasuries is the most liquid debt market in the world.

So, U.S. Treasury bonds, also known as T-bonds, are often touted as risk-free investments. The collapse of the government and society could change that, but not many consider it a real possibility.

Importantly, though, long-term government bonds have other risks, such as the risks posed by changing interest rates and inflation.

We’ll look at those after delving into the concept of long-term T-bonds’ credit risk as it relates to payment default.

Key Takeaways

• No bond, whether issued by the U.S. government or a corporation, is free of all risk.
• But U.S. government treasuries, including long-term bonds, are considered to be free of the risk of payment default.
• The U.S. government has an excellent credit rating and repayment history, and can take necessary steps to service existing debt obligations.
• There are, however, other risks for the long bond, such as interest rate risk, the effects of inflation, and opportunity cost.

Government Debt and Credit Ratings

A government’s ability to pay off a debt obligation is measured by a country’s credit rating. Much like an individual’s credit rating is determined by his or her borrowing and repayment history, so too is the U.S. government’s.

How It Works

From time to time, governments will borrow funds from other countries and individuals through loans and bonds.

The servicing and repayment of these bonds are carefully measured by financial institutions for creditworthiness.

Specifically, these entities look at a government’s lending and repayment history, the level of outstanding debt, and the strength of its economy.

In 2024, the highly respected credit rating company, Standard and Poor’s, affirmed its second highest possible rating, AA+, for the U.S. government.

Because U.S. government bonds are backed by the U.S. government and the U.S. has the most powerful economy in the world, these bonds are widely considered to be free from the risk of payment default.

When you purchase this type of bond, the U.S. government guarantees that the interest and principal will be paid according to the bond covenants. That is, payments will be made on time and in full.

Potential Pitfalls

Some economists point to the 25% rule which states that any long-term debt that exceeds 25% of the annual budget is excessive. Other economists do not share this view.

Only a monumental downturn in the economy or, possibly, a very rare circumstance during a time of war would prevent the U.S. government from repaying its short- or long-term debts.

However, even such events are unlikely to result in the U.S. government defaulting, since it has the ability to print additional money (monetary policy) or increase taxes (fiscal policy) if additional capital is needed.

Important

While the U.S. government has never defaulted on debt payments, and the S&P expressed confidence in its ongoing stability and economic resilience, it noted in its 2024 credit assessment that “A high debt burden, with net general government debt approaching 100% of GDP and interest to revenue over 10%, and difficulties garnering bipartisan cooperation to strengthen U.S. fiscal dynamics are credit weaknesses.”

Long-Term Bonds Have Other Risks

Interest Rate Risk

All bonds have interest rate risk, which is the risk of a loss of value if interest rates increase.

When interest rates change, the prices of bonds also change, but they move in the opposite direction. And the magnitude of these moves correlates to maturity.

That is, the longer the maturity of a bond, the greater the price volatility due to changing interest rates.

Conversely, the price change for very short Treasuries, such as Treasury bills which have maturities of under a year, is relatively minor. In fact, that’s why T-bills are called cash equivalents.

So the risk of a substantial change in value for long-term bonds is real. A general estimate is that a rise in yield of 100 basis points, or, say from 4% to 5%, causes an approximate 10% loss of principal for a 30-year bond.

Inflation Risk

With regard to long-term bonds that investors hold on to, persistent inflation erodes the value of the interest and principal payments over extended periods of time.

That, in turn, reduces your investment return.

Rising inflation also affects the value of bonds. When inflation rises, interest rates rise. And, as explained above, as interest rates rise, prices for outstanding bonds fall.

The Opportunity Cost

Normally, long-term bonds offer higher returns than those with shorter maturities.

However, due to the perceived risk-free appeal of ongoing interest and principal payments no matter what, long-term bonds offer lower rates of return compared to certain other investments, such as the stock market.

That means that by investing in long-term bonds, you can lose out on more attractive returns offered by higher yielding securities. This doesn’t mean that you should avoid Treasuries. But it suggests that diversification is called for based on financial needs, investment goals, and your risk-return profile.

To illustrate, consider some historical returns. If you’d invested $100 in 1928 in the S&P 500, in 2024 your investment would have been valued at $982,817.

If you’d invested $100 in 1928 in Treasury bonds, in 2024 your investment would have been worth $7,159.45.

Advisor Insight

Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY

Many people consider U.S. government bonds as “risk-free” because there is a very slim perceived chance that the country will default.

In my opinion, interest rate risk is currently the greater concern. The coupon payments the U.S. government will pay you are fixed at issuance, but the markets may create volatility for the issue that will cause the bond price (principal) to rise and fall during the life (term) of the bond. If the market interest rate fluctuates while your coupon is fixed, this may cause your investment to change in value. Also, if you choose to sell your bond before maturity you may experience a decline of principal.

Like all investments, risk is an integral part of the process. Invest with knowledge, so you know what your risks are and their effects on your capital.

What Is Default Risk?

It’s the risk that an issuer of a bond will fail to make the agreed-upon payments of interest and principal to the buyer of the bond. They will default on their obligation.

Are Long-Term Treasuries a Good Investment?

Depending on your purpose for investing, they could be. If you prefer low risk investments that guarantee income payments of interest and principal over a long time period, they could be a good investment (as long as you also invest in other, higher yielding securities). Many individuals, organizations, and foreign governments purchase Treasury bonds for their portfolios.

Can I Sell a U.S. Treasury Bond Before It Matures?

Yes, you can sell it at any time or hold on to it until maturity. Bear in mind that its value can change over time due to changing interest rates and demand. So, while you lose nothing if you hold a bond to maturity, if you have to sell before then, you may get less than what you paid for it.

The Bottom Line

Long-term U.S. government bonds are considered to be risk free as far as payments of interest and principal are concerned. That’s due to the ongoing stability of the U.S. government and its long history of always paying its debt obligations.

However, long-term Treasuries have other risks, including interest rate risk, the risk that inflation will erode the value of income received over time, and the risk that you’ll miss out on more attractive yield opportunities.

Clashes between the feds and the states heated up during the first Trump presidency

Reviewed by Caitlin Clarke

Donald Trump’s first presidential administration had frequent clashes between the federal government and the states, in which he claimed maximum power for the executive branch but at other times deferred to the states in matters typically regarded as the responsibility of a national government.

Some of the conflicts were set off by the COVID-19 pandemic, in which President Trump threatened to preempt governors’ and local officials’ shelter-in-place orders that shut down schools and businesses to prevent contagion of the novel coronavirus. For example, in June 2020, the U.S. Department of Justice attempted to file a brief, supporting plaintiffs who challenged Hawaii’s COVID-19 14-day quarantine for out-of-state visitors, only to be rebuffed by a Trump-appointed federal district court judge.

In April 2020, Trump tweeted that whether to “open up the states” and restart the economy was “the decision of the [p]resident,” not of state governors. He claimed to have “total” authority on the matter until the assertion was shot down by researchers and legal experts. He then backed down, leaving decisions about reopening to state governors while making certain that they understood his wishes for a quick start and implying that he could use federal funding as a lever.

The president and states also clashed over the federal stockpile of personal protective equipment to battle the pandemic, including whether states should have had access to it and where the responsibility lied for equipping hospitals with ventilators.

Key Takeaways

• State and federal government clashes about regulation were frequent during Donald Trump’s first presidential administration.
• Trump claimed maximum power for the executive branch but at other times deferred to the states.
• States pushed back when the federal government tried to relax regulations regarding fintech, data privacy, and cybersecurity.

States vs. the Federal Government—Who Has the Power?

Depending upon the situation, Trump often strayed from conservative federalist views, based on interpretation of the 10th Amendment, that the lion’s share of powers rightly belongs to the states, with limited powers for the national government. The amendment states that “powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Enumerated powers reserved for the federal government under the U.S. Constitution include national defense, foreign policy, international trade, immigration, interstate trade and patents, and the ability to coin money. Concurrent powers with the states include taxation, creating lower courts, and the right to build roads. Police powers and matters of health and safety are generally left to the states and localities.

But during the first Trump administration, more and more states—especially those led by Democrats—challenged federal regulatory changes in consumer protections for banking and financial services and the Affordable Care Act (ACA). States also took the lead in enacting data privacy and cybersecurity laws and litigating some antitrust matters, particularly with respect to communications technology.

In terms of investor and consumer protections, New York, California, and other states passed laws and regulations that increased consumer protections for financial services and emerging financial technologies (fintech). The states acted since they believed the federal government was slow to enact new rules and weakened existing protections.

States moved first to regulate data privacy and cybersecurity of financial services—which in Europe and elsewhere has been achieved at the national and European Union (EU) level. And they pushed to enforce antitrust laws against technology companies where they believed the federal government wasn’t taking strong enough action against consolidation, particularly in the mobile communications industry (such as the T-Mobile and Sprint merger).

States also took action ahead of the Federal Trade Commission (FTC) and U.S. Consumer Financial Protection Bureau (CFPB) to sue Equifax on behalf of consumers for a massive 2017 data breach that affected more than 147 million consumers.

37

The number of multistate lawsuits that were levied against the federal government in the first year of Trump’s first presidency, which was up from 13 in each of the last two years of the Barack Obama administration.

A total of 160 multistate lawsuits were filed against the federal government during the first Trump presidential administration.

The following is a look at five conflicts between the states and the federal government during the first Trump presidential administration over regulatory matters of concern to consumers and investors.

1.  Financial Technology (Fintech) Regulation

Financial technology companies—including money transmitters, online and app-driven mobile consumer lending platforms, and virtual currency licensees—are not covered by a single federal regulatory framework. Companies may be required to submit to licensing at the federal and state levels.

“Banking and mortgage banking always have had a dual regulatory environment,” says Scott Samlin, a partner in the consumer financial services group of the law firm Blank Rome in New York City, where he focuses on compliance and advisory work for financial services companies. “Typically, the federal government sets a floor, not a ceiling, and encourages the states if they provide greater protections to consumers. Typically, the states take the lead, and courts have typically ruled in favor of states and against the OCC (the U.S. Office of the Comptroller of the Currency) unless there is a direct conflict with federal law, such that the state law is preempted under the supremacy clause.”

Some fintechs, particularly money transmitters, have sought federal regulation, arguing that many different state regulators are impeding the advancement of the industry, particularly with respect to foreign competitors.

In July 2018, the OCC announced that it would start accepting applications for a special-purpose bank charter it had introduced in 2016 for fintech companies that take deposits, lend money, or paychecks and would be held to the same standards as national banks. But some states argued that state regulators are better equipped to protect consumers. New York—arguably the next most powerful regulator of banks and insurance companies in the U.S. after the federal government—along with other states, filed lawsuits that delayed the implementation of the OCC special bank charter.

On Dec. 19, 2019, the OCC filed an appeal of a federal court ruling in the Southern District of New York that agreed with New York’s Department of Financial Services (NYDFS) claim that the OCC lacked authority to grant fintech charters to nondepository institutions.

However, despite siding with the NYDFS overall, the federal court dismissed the DFS’s 10th Amendment claim, saying that the state’s claim “did not trigger the 10th Amendment because it related only to whether Congress had clearly chosen to preempt state chartering authority, rather than whether Congress had exceeded its enumerated powers,” according to an article by Dawn Causey, general counsel at the American Bankers Association et al., in the October 2019 ABA Banking Journal.

“The legal battle simmering in New York is the latest iteration of the pushmi-pullyu battle of wills in the dual banking system,” the article concludes.

“These tensions are most certainly going to continue,” Samlin says, “as long as there is a perception that the federal government is not being proactive in terms of adopting regulations in new areas like fintech and in enforcement of existing regulations.”

2. Cybersecurity and Data Privacy Regulation

Despite calls for a federal data privacy regulation corresponding to the EU’s General Data Protection Regulation (GDPR), the United States does not have a comprehensive national data privacy law or a comprehensive federal cybersecurity law.

Instead, the U.S. has a patchwork of federal laws, including the Health Insurance Portability and Accountability Act (HIPAA), the Privacy Rule and Security Rule, the Gramm-Leach-Bliley Act (Financial Modernization Act of 1999), the Fair Credit Reporting Act (FCRA) of 1986, the Electronic Communications Privacy Act of 1986, and the Federal Trade Commission Act to regulate various aspects of data privacy and cybersecurity under various agencies at the national level.

States’ Laws

In the absence of a comprehensive federal law—which has been talked about for years but was not advanced during the first Trump administration—states, including New York and California, have enacted their own respective cybersecurity and data privacy laws that have broad reach because they apply to businesses operating in their populous and influential states. These cybersecurity laws govern the collection, transmission, and use of sensitive personal data, including Social Security numbers and financial information, and include requirements for data breach notification.

The New York State DFS Cybersecurity Regulation took effect in March 2017. In 2018, California enacted legislation regulating the cybersecurity of the Internet of Things. The even more far-reaching California Consumer Privacy Act of 2018 took effect on Jan. 1, 2020, and closely resembles the European GDPR.

In turn, the National Association of Insurance Commissioners (NAIC) crafted its model cybersecurity law after the NYDFS cybersecurity regulation.

Important

Unlike banking, which is regulated by federal and state authorities, insurance in the U.S. is regulated by the states, which often craft their regulations after the NAIC model laws and regulations.

Federal Regulation

In December 2019, the federal government’s first widely applicable cybersecurity regulation was approved in a U.S. Securities and Exchange Commission (SEC) rule change requiring that members of the National Securities Clearing Corp. (NSCC) (and organizations applying for membership) confirm that they have a cybersecurity program. Organizations reporting trade data also can be required to submit a cybersecurity confirmation effective as of Dec. 9, 2019, when the rule was approved by the SEC.

“When considered with the SEC’s Statement and Guidance on Public Company Cybersecurity Disclosures, there is a clear movement towards regulation of cybersecurity at the federal level,” wrote Richard Borden and Joshua Mooney, attorneys with the law firm White and Williams, in a client alert.

Mooney, who is chair of the cyber law and data protection group at the firm, said in an email, however, that in this instance, the federal and state rules are not in conflict.

“The NSCC rule and DFS cyber regs are complementary and are not at cross-purposes. … In fact, the NSCC certification, which requires a company, as part of its certification process, to attest to a third-party assessment or internal audit of the company’s cyber program, will instead accept certification under the DFS cyber regulations as satisfaction of this assessment requirement,” Mooney said.

3. Federal vs. State Fiduciary Rules for Financial Advisors

Under the Obama administration, the U.S. Department of Labor (DOL) drafted new regulations for certain financial advisors requiring them to meet a fiduciary standard, which legally mandates that they put clients’ best interests first. It is a higher accountability standard than the previous suitability standard, which requires a recommendation only to be appropriate for the customer.

But in February 2017, shortly after taking office, President Trump issued a memorandum attempting to delay the rule’s implementation by 180 days in order to study the potential impact of the new regulations.

A year later, in March 2018, in a lawsuit brought by the U.S. Chamber of Commerce and the Financial Services Institute as well as other parties, the Fifth U.S. Circuit Court of Appeals in New Orleans vacated the Obama administration’s fiduciary rule in a two-to-one decision.

States Step in with Fiduciary Standards

Since then, some states have stepped in to introduce their own fiduciary standards for retirement investment advisors. New York, Massachusetts, Nevada, and New Jersey are among the states that have imposed—or are considering imposing—their own laws or regulations requiring a fiduciary standard for certain financial advisors.

A state court upheld NYDFS Amended Rule 187 requiring broker-dealers, agents, and insurance brokers selling annuities and life insurance to state residents to do so in the “best interest” of their clients, effective Aug. 1, 2019, for annuities and Feb. 1, 2020, for life insurance. The rule was opposed by the National Association of Insurance and Financial Advisors among other groups and was supported by consumer groups.

In a July 2018 news release, then-NYDFS Commissioner Maria Villa said, “The regulation will fill in regulatory gaps to protect New York consumers from the elimination of the federal Department of Labor’s Conflict of Interest Rule, which the Trump administration failed to protect on appeal after a ruling from the U.S. Fifth Circuit Court of Appeals, and also supplements existing consumer protections that already exist in New York, including setting reasonable limits on compensation and compensation transparency for the sale of a life insurance or annuity product in New York State.”

4. Antitrust Regulations

New York, California, and Massachusetts emerged as some of the most active states in utilizing state and federal laws prohibiting unfair competition and restraint of trade under the first Trump administration.

In 2019, New York State Attorney General Letitia James and then-California Attorney General Xavier Becerra joined forces with more than a dozen other state attorneys general to try to halt the proposed merger of mobile service providers T-Mobile, a subsidiary of Deutsche Telekom AG, with Sprint Corp.

The complaint was filed in federal district court in Manhattan by those states, as well as Colorado, Connecticut, the District of Columbia, Maryland, Michigan, Mississippi, Virginia, and Wisconsin (and later, by several other states), alleging that the merger of two of the world’s largest wireless companies would deprive consumers—especially low-income consumers—of the benefits of competition and drive up prices for cellphone services.

Then-FCC Commissioner Ajit Pai had argued the deal would not be anticompetitive and would enhance the development of 5G technology. And T-Mobile and Sprint had already received approval from the U.S. Department of Justice and the Federal Communications Commission, after the companies agreed to sell off Sprint’s prepaid phone business and Boost mobile, and sell Spectrum to Dish Network Corp.

A federal judge in Manhattan ruled in favor of the $26 billion merger, and the deal was consummated in April 2020.

However, actions against other companies were taken. In October 2020, the U.S. Department of Justice and state attorneys general brought antitrust charges against Alphabet Inc., the parent of Google, over its online advertising business.

Apple Inc. fell under scrutiny by authorities over its app store. Also, the European Commission opened an antitrust investigation to determine if Apple’s conduct in connection with Apple Pay violated EU competition rules.

5. Marijuana Banking Regulation

Conflicts between federal narcotics and anti-money-laundering laws and state laws allowing the production and sale of marijuana for medicinal and recreational purposes have created a banking crisis for the fledgling industry in the U.S. The marijuana industry considers this conflict to be one of the major obstacles to the growth and development nationally of the legal marijuana industry.

While Donald Trump campaigned in 2016 in favor of leaving marijuana legalization to the states, his first presidential administration took actions at the federal level that conflicted with state laws.

In 2018, then-Attorney General Jeff Sessions rescinded an Obama-era policy that discouraged federal authorities from prosecuting marijuana activities that are legal in the states. Sessions said that federal prosecutors would have discretion as to what actions to take when state rules conflict with federal drug laws. The rescission dismayed government officials in the eight states that had legalized recreational use, as well as industry proponents and conservative Republican members of Congress.

Legislation designed to ease banking restrictions on the legal marijuana industry in the states was introduced in Congress and passed with bipartisan support in the U.S. House of Representatives. But the Secure and Fair Enforcement (SAFE) Banking Act failed to come to a vote in the Republican-led U.S. Senate.

President Trump’s fiscal year 2021 budget also removed a rider that prevented the U.S. Justice Department from using federal funds to interfere with state medical marijuana laws, though the rider had been approved every year since 2014.

Stepping in again to fill a void in federal regulation, the New York Department of Financial Services stated in July 2018 that it “will not impose regulatory actions” on any New York state-chartered bank or credit union for opening an account or starting a new banking relationship with a medical marijuana-related business that complies with federal and state laws.

But when President Trump signed a funding bill in December 2018, he attached a statement indicating that he believed the federal government could enforce federal drug laws against individuals who comply with state medical marijuana laws.

And in March 2020, at a House Appropriations Financial Services and General Government Subcommittee hearing, then-Treasury Secretary Steven Mnuchin said he would not take administrative action to protect banks servicing marijuana businesses from being penalized by federal regulators. Mnuchin told the committee that it was up to Congress to enact legislation to resolve the problem.

“Congress can act to preempt anything that is left to the states. It is only generally left to state power when Congress doesn’t act. But in our legislative environment, it isn’t that easy to get legislation passed,” says Samlin, of the law firm Blank Rome.

What Is the Status of Fintech in a Second Trump Presidency?

Fintech is likely to find a more supportive regulatory environment in Donald Trump’s second presidential administration. One possible development is if fintech companies pursue banking charters, such as for industrial loan companies.

What Is the Status of Cybersecurity and Data Security in a Second Trump Presidency?

The second Trump administration is rolling out technology policy changes with potentially significant impacts. Among the agencies affected are the Federal Trade Commission (FTC), the Consumer Financial Protection Bureau (CFPB), and the Privacy and Civil Liberties Oversight Board (PCLOB).

What Is the Status of Federal Financial Advisor Fiduciary Standards?

In September 2024, new regulations from the U.S. Department of Labor (DOL) were to take effect that extended fiduciary protections to individual retirement accounts (IRAs). Under the Retirement Security Rule, even financial advisors who are not registered investment advisors must put their clients’ interests first when it comes to IRAs.

However, in July 2024, a U.S. district court in Texas stayed the effective date of the rule. The DOL under the Joe Biden presidential administration appealed the stay in September 2024, but in February 2025, the DOL under the second Trump presidential administration filed a motion to pause the court case.

What Is the Status of Antitrust Regulations in a Second Trump Presidency?

The second Trump administration is expected to shift antitrust enforcement from merger scrutiny to concerns related to Big Tech and alleged censorship. There may also be enforcement actions targeting alleged collusion on diversity, equity, and inclusion (DEI) issues and potential agency focus on “industries under high public scrutiny and foreign corporations,” according to The National Law Review.

What Is the Status of Marijuana Reform in a Second Trump Presidency?

President Trump has not yet expressed his stance on marijuana reform. In the past, however, he has indicated support for both the SAFE Banking Act and cannabis reclassification. The U.S. Department of Justice under President Biden proposed reclassifying marijuana from a Schedule I controlled drug to a Schedule III drug, which would keep it illegal at the federal level but allow it to be lawfully dispensed by prescription.

The Bottom Line

Looking ahead to the second Trump presidential administration, consumers and investors probably can expect more of the same state and federal conflicts. It remains uncertain whether legislators in Congress will be able to work together to resolve these issues.

Reviewed by David Kindness
Fact checked by Timothy Li

What Is “Shark Tank”?

The underlying theme of the Shark Tank TV series is for either the investors (called Sharks) or the entrepreneurs (pitching their business) to convince the other side to accept the valuation of their business and negotiate a deal based on it. The entrepreneurs tend to come in with high valuations, and the Sharks like to counter with lower valuations.

How entrepreneurs and the Sharks value businesses presented on the show varies, but a good company valuation considers certain factors such as revenue, earnings, and the value of companies within the same sector. In return for giving up a stake in the company, the entrepreneur gets funding, but more importantly, they get access to the Sharks, their network of contacts, their suppliers, and their experience.

How the Sharks determine the amount to invest in the company and the percentage of ownership each is willing to consider comes down to forecasting revenue, earnings, and applying a valuation to the company.

Key Takeaways

• The investors hosting Shark Tank typically require a stake in the business—or a percentage of ownership—and a share of the profits.
• A revenue valuation is often determined based on prior sales and revenue figures, as well as any sales in the pipeline.
• The Sharks use a company’s profit compared to the company’s valuation from revenue to come up with an earnings multiple.

Shark Tank Valuation Methods

Revenue Multiple

Typically, an entrepreneur will ask for an amount in exchange for a percentage of ownership. For example, an entrepreneur might ask for $100,000 from the Sharks in exchange for 10% ownership of the company. From there, the Sharks begin to determine whether it’s properly valued.

The Sharks will usually confirm that the entrepreneur is valuing the company at $1 million in sales. The Sharks would arrive at that total because if 10% ownership equals $100,000, it means that one-tenth of the company equals $100,000, and therefore, ten-tenths (or 100%) of the company equals $1 million.

If the company is valued at $1 million in sales, the Sharks would ask what the annual sales were for the prior year. If the response is $250,000, it will take four years for the company to reach $1 million in sales. If the response were $75,000 in sales, the Sharks would likely question the owner’s valuation of $1 million.

Advisor Insight

Revenue multiples are used by venture capitalists, angel investors, and other investors to value startups looking for funding—along with other financial performance measurements.

However, if last year’s sales were $250,000, but the entrepreneur recently entered into a sales agreement with Walmart to sell $600,000 worth of product, the valuation would be more attractive to the Sharks based on the sales forecast. In other words, the valuation doesn’t only consider the prior year’s sales and revenue but also what the company has in its sales pipeline.

Costs

As calculated by most businesses, revenue doesn’t account for how much it costs to produce goods or services. It is only the dollar amount of total sales—so the Sharks ask about costs. For example, they might ask what it costs to manufacture the company’s product and its selling price. This will help them calculate product margin. They will inquire about other costs, such as marketing, research and development, and salaries or wages paid to the owner or employees to get an idea of how much revenue the business keeps as profit.

Earnings Multiple

The companies on “Shark Tank” are not publicly traded, meaning they don’t have equity shares or published earnings multiples for investors to consider. However, the Sharks can still use the company’s profit compared to the company’s valuation from sales revenue to come up with an earnings multiple.

For example, if the company is valued at $1 million and the owner earns $100,000 in profit, the company would have an earnings multiple of 10 or ($1 million / $100,000). However, there is no way to know whether an earnings multiple of 10 is good for the company, so the Sharks may decide to use a comparable company analysis to find out.

Note

A comparable company analysis compares the financial performance of several similar companies to determine whether a company being evaluated is correctly valued.

Let’s say in our earlier example that the company is a clothing retailer. The Sharks can compare the multiple to those of other companies within the same industry.

So, let’s say the entrepreneur is pitching a clothing brand with $1 million in annual sales with $100,000 in profits. The entrepreneur could apply the metrics of the specialty retail apparel sector by using the sector’s average earnings multiples. Let’s say the sector has an average earnings multiple of 12.

At 12x earnings, this would value the business at $1.2 million or (12 x $100,000). Based on this valuation, the entrepreneur can justify the deal for a 10% stake in the business for a $100,000 investment from the sharks.

Future Market Valuation

A future valuation could also be calculated in the same way the revenue and earnings multiples are. The only drawback is that the numbers are forecasts and can be inaccurate. The Sharks would likely ask what the entrepreneur forecasts for sales and profits in the next three years. They would then compare those numbers to those of other companies in the retail clothing industry.

The entrepreneur might forecast that earnings in the next three years would lead to $400,000 in earnings in year three. If the retail industry typically has a 14.75x forward earnings multiple, the future valuation would be $5.9 million in earnings or (14.75 x $400,000).

Advisor Insight

Sharks also ask for the previous year’s sales and sales pipelines to estimate future demand for a product or service.

The Sharks ultimately want to get their investment back and earn a profit. If they agree that the company could generate $5.9 million in business by year three, a 10% stake for $100,000 might be attractive. However, it’s possible that the business might not generate $400,000 in profit by year three. As a result, the sharks would likely demand a higher ownership percentage, counteroffer with a lower loan amount, or propose some combination of both.

Valuation of Intangibles

The show would be without drama or excitement if the Sharks valued a company solely based on figures. Valuating intangibles is one of the reasons the show is so popular. Much like other seasoned investors, the Sharks consider the whole package—numbers, story, and experience—in their valuation of companies, though the numbers are often the most significant part of this exercise.

But other intangibles are also important. An entrepreneur might have established a brand in their local area that became synonymous with quality and customer service. They might also have filed patents or have intellectual property that might have value. An owner’s experience, access to retail outlets for selling products, or supply chains are all valuable, although not in a monetary sense.

Special Considerations: Risks to Valuation

The Sharks might say they can’t apply the same valuation to the entrepreneur’s company based on valuation metrics from publicly traded companies. There are several distinctions between a small business and a public corporation.

A large, established retailer might have thousands of stores worldwide, but a small business may only have a few locations. Though the growth rate is justifiably higher for the small business, the risk is much larger due to the risk of failure and liquidity risk in terms of an exit strategy. Liquidity measures how easily an investment can be bought or sold. If there are many buyers and sellers vying for an investment, there is ample liquidity. If there are few buyers and sellers, there’s illiquidity.

The lack of liquidity creates more risk for the Sharks, which entails applying risk-adjusted discounting to make the reward worth the risk. As a result, the Sharks have much more wiggle room to base their offers on a risk-adjusted discounted valuation.

The Sharks could counteroffer with a higher stake in the company, say 30% ownership for a $100,000 contribution. Even if the valuation metrics (based on revenue and earnings) indicate that the Sharks should have a lower stake, the risk of loss from investing in an unknown company usually adds to the Shark’s ownership stake.

When Did “Shark Tank” Premier on TV?

The first episode of “Shark Tank” debuted on Aug. 9, 2009, on ABC in the United States. However, the show is the American version of the international show “Dragons’ Den.” The very first iteration of the format is thought to be Japan’s 2001 “Money Tigers.”

Who Is the Wealthiest “Shark” on Shark Tank?

Mark Cuban is the richest of the Sharks on Shark Tank, with an estimated worth of more than $5.7 billion as of Feb. 2025.

What Are Some Ideas That Sharks Passed on But Were Successes?

The Sharks aren’t always right in their assessments. Notable examples of ideas rejected on the show but became very successful include Ring, Coffee Meets Bagel, and Chef Big Shake.

The Bottom Line

Shark Tank is a popular reality show in which wealthy investors valuate startups who pitch for funding. The investors use several popular valuation techniques to debunk or concur with the owner’s valuation and decide whether to grant them funding in return for an ownership stake.

Reviewed by Samantha Silberstein
Fact checked by Jen Hubley Luckwaldt

Commodities are an important aspect of Americans’ daily lives, providing the food they eat and the energy used to propel their cars. A commodity is a basic good traded in large volumes and interchangeable with other goods of the same type.

Commodities are either for immediate delivery in spot trading or for conveyance later when traded as futures. Commodity markets deal in metals (aluminum, copper, gold, lead, nickel, silver, zinc, etc.) and “soft” items (cocoa, coffee, sugar, oil, etc.).

Key Takeaways

• Commodities are typically sorted into four broad categories: metal, energy, livestock, and meat and agricultural products.
• For investors, commodities can be an important way to diversify their portfolios beyond traditional securities.
• Commodities are considered risky investments because the supply and demand of these products are affected by events that are difficult to predict, such as weather, epidemics, and natural and human-made disasters.
• There are many ways to invest in commodities, including futures contracts, options, and exchange-traded funds (ETFs).

Commodities are an important way for investors to diversify their portfolios beyond traditional securities. Because the prices of commodities tend to move in the opposite direction of stocks, some investors rely on returns from commodities during periods of market volatility.

In the past, commodities trading required significant amounts of time, money, and expertise and was limited to professional traders. Today, there are far more options for participating in the commodity markets.

A History of Commodities Trading

Trading commodities is an ancient profession with a longer history than the trade in stocks, bonds, and, according to many anthropologists, money. The rise of numerous empires can be directly linked to their ability to create complex trading systems and facilitate the exchange of commodities. This also means that the history of colonialism can only be understood in light of the history of commodities trading.

Before the beginnings of rail travel and industrial shipping in the 19th century, the cost of sending goods across continents and vast oceans meant only those items that fetched steep prices per unit, such as spices, coffee, cocoa, gold, and silver, were worth trading farther than the local markets.

Two moments brought us to the present, when the most inexpensive goods on one side of the world can be found in markets on the other: The first resulted from incredible changes in transport technologies (railroads, steam engines, the first refrigerated train cars, and so forth) in the 19th century, and the second came on the heels of the introduction of huge bulk carriers and the massive harbor-based facilities after World War II and the Suez Canal crisis of the late 1950s.

By some estimates, the shipping cost for bulk goods decreased about 90% between the 1870s and a century later. Whereas in the 1850s, one would ship only the costliest goods abroad, in recent decades, materials with any perceptible value have been loaded into containers to be sold in the global marketplace. Indeed, at this point, even garbage (metal scrap, recyclable materials, and refuse headed for landfills) is worth the relatively low cost it takes to ship it an ocean away.

As this makes clear, commodities trading is not just ancient but also among the most modern professions, taking on board the latest technological advances to increase global trade volume.

Trading in commodities is done through an exchange, which refers both to a physical location where the trading occurs and to the legal entities formed to enforce standardized commodity contracts and related investment products.

Exchanges have gone through the consolidation found in other industries in recent years. The majority of exchanges carry a few different commodities, although some specialize in a single type.

Note

In the United States, there are the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange, and the Intercontinental Exchange in Atlanta.

Special Characteristics of the Commodities Market

In the broadest sense, the basic principles of supply and demand drive commodities markets. Changes in supply affect demand, and low supply equates to higher prices. So, any disruptions in the supply of a commodity, such as a virus that affects cattle or a cold snap in a citrus area like Florida, can cause a spike in the generally stable and predictable demand for a commodity.

Global economic development and technological change can also have a great effect. For example, the emergence of China and India as significant manufacturers has led to a prodigious increase in demand for industrial metals, making them more difficult to get in other parts of the world.

Types of Commodities

Commodities are broadly sorted into four categories: metal, energy, livestock, and meat and agricultural products.

Metals

Metals commodities include gold, silver, platinum, and copper. During periods of market volatility or bear markets, many investors put their money into precious metals, particularly gold, because of their status as having reliable value. Investors also do so to hedge against high inflation or currency devaluation.

In recent years, besides the traditional trade in metal as a store of value and for industrial manufacturing, the major story in these commodities has been about the tech industry’s need for rare earth elements. Some, like dysprosium, erbium, europium, gadolinium, and holmium, are used in speakers, electric vehicle motors, and smartphones. Another element, gallium, is frequently found in semiconductors and LEDs, and tantalum and niobium are indispensable in producing capacitors and resistors. Without these metals, it’s difficult to see how many advanced goods would have been miniaturized.

Metal commodities that play a central role in batteries, such as lithium, cobalt, and nickel, are in high demand for building renewable energy storage. As a result, considerable competition for access to these critical metals exists.

Note

European, American, and Chinese companies have been sourcing some of these metals in several central African countries, including the Congo. This raises ethical and political questions about who benefits from this trade, especially when mining some of these metals creates significant problems for local ecology and the people doing the extraction.

Energy

Energy commodities include crude oil, heating oil, natural gas, and gasoline. Global economic developments and reduced oil outputs from established oil wells around the world have historically led to rising oil prices, as demand for energy-related products has gone up at the same time that oil supplies have dwindled.

Investors interested in exposure to the energy sector need to understand how economic downturns, shifts in production enforced by the Organization of the Petroleum Exporting Countries (OPEC), and advances in alternative energy sources—wind power, solar energy, and biofuels, for example—all have a huge effect on the market prices for energy commodities. That’s not to say that the trade in oil has been going away: In 1998, daily oil production worldwide was around 73 million barrels per day, which increased to 96.3 million barrels per day 25 years later. That figure rose to 102.6 million barrels per day in 2024, according to the U.S. Energy Information Administration.

Livestock and Meat

Livestock is the term for the domesticated animals raised on farms for use as food, labor, and more. The breeding and slaughtering of these animals supplies the trade in meat, milk, dairy, animal byproducts used in industrial and household goods, leather, and wool. Overall, as a commodity, livestock is valued chiefly for its meat.

The CME is the major U.S. exchange for the livestock trade, offering futures and options on the different types of them. Livestock is an essential part of the agricultural commodities market, with a far-reaching effect on the global food supply.

The most common meats traded include beef, pork, lamb, and poultry, such as chicken and turkey. The meat market is global, with trade agreements, tariffs, and international relations playing crucial roles in shaping how meat is traded. The meat supply chain involves animal rearing, slaughtering, processing, and distribution. Efficient logistics are necessary to maintain the quality and safety of meat, which can affect market prices and availability.

Consumer Trends

While some consumers have shifted toward alternative protein sources like plant-based and lab-grown meats, the United Nations says it anticipates worldwide meat protein consumption to surge about 14% by 2030 from 2020 levels. This surge is expected because of worldwide increases in income and population.

The increasing demand for livestock is driven by trade in Asia and the Middle East, where local production cannot fully satisfy consumer needs. In recent years, import demand in several middle- and high-income Asian nations has grown because of dietary shifts toward more animal-based products. International trade agreements have played a significant role, incorporating specific clauses for meat products to increase market access and open new trading partnerships.

By 2030, the supply of beef, pork, poultry, and sheep meat is estimated to expand by 5.9%, 13.1%, 17.8%, and 15.7% respectively. In the U.S., shifting consumer tastes, an aging demographic, and slower population growth should stabilize per capita meat consumption at about its early 2020s levels. One widely noted trend in the livestock trade is the growing preference for poultry over other sources of protein. There are several reasons for this change, two of which stand out: Poultry’s lower cost makes it a more affordable source of meat worldwide, and white meat is seen as a healthier option and more convenient to prepare.

Note

Poultry is expected to constitute 41% of all meat protein sources by 2030.

Meanwhile, the livestock commodities sector has faced growing calls to address sustainability and environmental concerns. Consumers are increasingly interested in knowing, e.g., the industry’s carbon footprint and are looking for protein from more sustainable farming sources.

Agricultural Products

Agricultural commodities include corn, soybeans, wheat, rice, cocoa, coffee, cotton, and sugar. For investors interested in the agricultural sector, population growth—combined with limited agricultural supplies—could provide profits from rising agricultural commodity prices.

In recent decades, the agricultural sector has undergone several significant shifts related to technological advances, environmental concerns, changes in market dynamics, and policy shifts. Here are some of the key changes shaping the sector:

• Climate change: This is crucial for any discussion of the future of this sector. Changes in weather patterns, increased incidence of extreme weather events, and shifting climatic zones have already affected crop yields, pest and disease patterns, and farming practices.
• Consumer shifts: There have been notable changes in consumer preferences toward organic and locally sourced foods. This has influenced farming practices, the types of crops grown, and how agricultural goods are marketed and distributed.
• Genetic modification and biotechnology: Genetically modified organisms and biotechnology have been controversial yet transformative over the past several decades. Taking advances in the biological sciences and applying them to agriculture has enabled the creation of crop varieties with improved resistance to pests, diseases, and environmental stresses. However, they have also sparked debates about their health and environmental consequences.
• Globalization: The now-worldwide scope of agricultural trade means few farming communities in the world aren’t feeding into the global market. This has led to increased competition, crop choice changes, and global supply chain shifts. Trade policies and agreements have also greatly changed market dynamics and farming practices.
• Government policies and subsidies: Government interventions in the form of subsidies, support programs, and regulations have had significant effects on farming practices, crop choices, and the overall viability of different agricultural sectors.
• Sustainable farming: There has been a growing emphasis on sustainable farming practices because of climate change and the ecological effects of large factory farming. This includes a shift toward organic farming, integrated pest management, and conservation agriculture, which focus on minimizing the environmental effects of farming.
• Technological advances: The adoption of new agriculture technologies has led to massive changes in the sector. GPS systems, Internet of Things devices, drones, automated machinery, and big data analytics have greatly increased the efficiency and yields of farming practices.
• Urbanization and other changes in land use: The expansion of urban areas and changes in land use have decreased in certain areas the amount of land available for agriculture, creating the need for methods of farming that can increase yields per acre.

What Moves Commodity Prices?

Commodity investment returns are based on different components, each of which plays a distinct role. Let’s discuss some of them:

• Changes in costs: Basic gains or losses shift based on differences in carry costs, storage, insurance, and financing.
• Currency fluctuations: Since most commodities are priced in U.S. dollars, changes in the dollar’s value can greatly affect commodity prices. A weaker dollar makes commodities cheaper in other currencies, potentially increasing demand, while a stronger dollar has the opposite effect.
• Geopolitical and economic stability: Political events, economic policy, and instability in key regions can significantly influence commodity prices. Wars, political unrest, or economic sanctions where a commodity is produced can disrupt supply chains and affect prices.
• Global economic trends: The overall health of the global economy greatly influences the demand for individual commodities. Economic growth typically leads to increased demand, while economic downturns do the reverse.
• Government policies and regulations: Tariffs, subsidies, trade agreements, and environmental regulations all influence commodity prices. Policies restricting trade or production can lead to higher prices, while subsidies and incentives to certain industries can increase supply and potentially lower prices.
• Inflation and interest rates: Investments in commodities are usually a hedge against inflation. When there’s inflation, commodities typically rise along with it, providing some protection for investors who have them as part of their portfolio. Interest rate changes can also influence commodity prices by affecting the cost of holding or financing commodities.
• Market speculation: Traders speculating on future prices can drive changes in the current prices of commodities.
• Storage and transportation costs: The expenses related to storing and transporting commodities, especially for perishable goods, can change, significantly affecting their price.
• Supply and demand: This is arguably the most fundamental factor. If the supply of a commodity is low relative to demand, prices rise. Conversely, if supply is high and demand is low, prices fall.
• Technological advances: Technological gains have historically helped lower the cost of commodity production. Alternatively, they can also lead to an uptick in demand for other materials. For instance, advances in renewable energy technology should help, at some point, shift the demand for fossil fuels.
• Weather and environmental events: The weather is a crucial influence on the production and supply of commodities, especially agricultural products and energy commodities like oil and natural gas. Droughts, floods, hurricanes, and other climatological events can disrupt supply chains and production, leading to price volatility.

Using Futures to Invest in Commodities

Futures are a prominent way to engage in the commodities market. A futures contract is a legal agreement to buy or sell a particular commodity at a predetermined price at a specified time. The buyer of a futures contract is taking on the obligation to buy and receive the underlying commodity when the futures contract expires. On the flip side, the seller is obliged to deliver the underlying commodity at the contract’s expiration date.

Futures contracts are available for every kind of commodity. Generally speaking, two types of investors engage in the futures markets for commodities: commercial or institutional users of the commodities, and speculative investors.

Commercial and Institutional Purchasers of Futures

Many companies use futures contracts as part of their budgeting process and to mitigate shifts in cash flow. This is especially suitable for businesses that depend on commodities for their operations. These firms can reduce the risk of financial losses if prices fluctuate by taking positions in the commodities markets.

A good example of this is in the airline industry. Airlines require large quantities of fuel, and stable fuel prices are vital for their financial planning. To achieve some price stability, airlines hedge using futures contracts. With these contracts, airlines lock in fuel prices for a certain period. They thus protect themselves from the unpredictable swings in crude oil and gasoline prices, securing more predictable and stable operating costs.

Farming cooperatives may employ futures contracts to hedge against market volatility. Without this strategy, the unpredictability of commodity prices could pose significant financial risks, including bankruptcy, for businesses that need relatively stable prices to manage their operating expenses.

For example, consider a cooperative of wheat farmers. The price of wheat can fluctuate widely because of weather conditions, global supply, and market demand. To manage this uncertainty, the cooperative could use futures contracts to lock in a selling price for their wheat crop ahead of the harvest. Doing this ensures a guaranteed price, regardless of future market fluctuations. Suppose market prices drop significantly by the time they harvest. In that case, the cooperative is protected from the lower prices because they had already secured a higher selling price through the futures contract. Either way, they gain some predictability and can budget for the future accordingly.

Speculators in Commodities Futures

Speculators in commodities tend to be sophisticated investors or traders who purchase assets for short periods and employ certain strategies to profit from price changes. Speculative investors hope to profit from changes in the price of the futures contract. These types of investors typically close out their positions before the futures contract is due. As a result, they typically never take actual delivery of the commodity itself.

If you wish to speculate on commodity prices and do not have a broker who trades futures contracts, you may have to open a new brokerage account. You will likely need to fill out a form acknowledging that you understand the risks of futures trading. Futures contracts require a different minimum deposit depending on the broker, and the value of your account will increase or decrease with the value of the contract. If the value of the contract decreases, you may be subject to a margin call and required to deposit more money into your account. Because of the high level of leverage typically involved in such contracts, small price moves in commodities can result in large returns or considerable losses; a futures account can be wiped out or doubled in a matter of minutes.

There are advantages to using futures contracts to participate in the commodities market. Analyzing particular investments is simplified because it’s a “pure play” on the underlying commodity. This means that you can focus solely on the price moves of the commodity itself without dealing with the complexities of company-specific factors that can affect stocks. In addition, futures trading can lead to significant profits. This is partly because futures contracts allow for high leverage: With a minimum deposit account, investors can control full-size contracts. This leverage means that you can take a strong position in the market even with a relatively small amount of capital.

However, while this can magnify profits, it also increases the risk of considerable losses. Therefore, futures trading requires careful risk management and is generally more suitable for experienced investors.

Futures Options

Because the markets can be very volatile, direct investment in commodity futures contracts can be very risky, especially for inexperienced investors. If a trade goes against you, you could lose your initial deposit and more before you have time to close your position.

Most futures contracts offer the ability to purchase options. Futures options can be a lower-risk way to enter the futures markets. One way of thinking about buying options is that it’s like putting a deposit down on something instead of purchasing it outright. With an option, you have the right—but not the obligation—to follow through on the transaction when the contract expires. Hence, if the price of the futures contract doesn’t move as you anticipated, you have limited your loss to the cost of the option.

Using Stocks to Invest in Commodities

If you’re interested in exposure to particular commodities markets, you can invest in the stocks of companies operating within them. For example, investors interested in the oil industry could put their money into oil drilling companies, refineries, tanker companies, or diversified oil companies. Those interested in the gold sector can purchase stock in mining companies, smelters, refineries, or any firm that deals with bullion.

Stocks are generally considered less prone than futures contracts to volatile price swings. Stocks are easier to buy, hold, trade, and track. Plus, you can narrow down where you put your money to this or that particular sector. This requires, of course, due diligence in researching the specific companies that interest you.

Investors can also purchase options on commodities such as natural gas options and oil companies and refineries options. Like options on futures contracts, options on commodity stocks require a smaller investment than buying stocks directly. Thus, while your risk for a stock option may be limited to the cost of the option, the price changes of a commodity may not directly mirror the price activity of a company’s stock with a related investment.

An advantage of investing in stocks to gain exposure to commodities is that you can already engage in trading with your brokerage account. The information on a company’s financials is readily available, and stocks are often highly liquid. This is not always the case with other forms of investing in commodities.

There are relative disadvantages to investing in stocks to engage in the commodities market. Stocks are never a “pure play” on commodity prices. In addition, the price of a stock may be influenced by company-related factors that have nothing to do with the value of the commodities you’re trying to track.

Using ETFs and Notes to Invest in Commodities

ETFs and exchange-traded notes (ETNs) are other ways to engage in the commodities market. ETFs and ETNs trade like stocks and enable you to speculate on fluctuations in commodity prices without investing directly in futures contracts.

Commodity ETFs tend to track the price of a particular commodity or a group of them using futures contracts. Occasionally, you can invest in an ETF with the actual commodity in storage. Meanwhile, ETNs involve unsecured debt securities meant to mimic the price changes of a particular commodity or a group of them found in an index. ETNs are backed by the issuer.

You don’t usually need a special brokerage account to put money into an ETF or ETN. There are also no management or redemption fees with ETFs and ETNs because they trade like stocks. However, not all commodities have ETFs or ETNs associated with them.

Warning

One downside is that a major change in the price of the commodity might not get reflected point for point in the underlying ETF or ETN. In addition, ETNs have credit risk associated with them since they are backed by the issuer.

Using Mutual and Index Funds to Invest in Commodities

While you cannot use mutual funds to invest directly in commodities, these funds might have holdings in commodity-related industries, such as energy, agriculture, or mining. Like the stocks they invest in, the mutual fund’s shares are affected by factors beyond just changes in the commodity’s price, including more general changes in the stock market and company-specific factors.

However, there are some commodity index mutual funds that invest in futures contracts and commodity-linked derivatives. These can provide a more direct exposure to changes in commodity prices.

By investing in mutual funds, you get the benefit of professional money management, added diversification, and liquidity. Unfortunately, some mutual funds have high management fees.

Using Commodity Pools and Managed Futures to Invest in Commodities

A commodity pool operator (CPO) is a person or limited partnership that collects funds from investors and pools these resources to put into futures contracts and options. CPOs must provide you with periodic account updates and annual financial reports. They must also keep records on all investors, transactions, and any additional pools they are operating.

Typically, CPOs employ a commodity trading advisor (CTA) to advise them on trades for the pool. CTAs contributing professional investment advice must be registered with the U.S. Commodity Futures Trading Commission (CFTC). Registration includes a thorough background check to ensure they are fit to be giving financial advice.

You might want to participate in a commodity pool for several reasons. One advantage is that you gain access to professional investment advice from the CTA, which is particularly helpful for those not well-versed in futures trading. In addition, the pooling of funds means there can be a larger capital base to invest, which can broaden the opportunities and help diversify risk. Nevertheless, if you join a closed fund, there could be a uniform contribution required. This means each investor must commit to the same level of capital.

Want to learn more advanced investing and trading strategies? Check out our new guide—Level Up Your Investing Strategy—to elevate your approach and maximize returns.

What Is the Difference Between Hard and Soft Commodities?

Hard commodities are natural resources that must be mined or extracted. They include metals and energy commodities. Soft commodities refer to agricultural products and livestock.

The key differences include how perishable the commodity is, whether extraction or production is used, the amount of market volatility involved, and the level of sensitivity to changes in the wider economy. Hard commodities typically have a longer shelf life than soft commodities. In addition, hard commodities are mined or extracted, while soft commodities are grown or farmed and are thus more susceptible to problems in the weather, the soil, disease, and so on, which can create more price volatility. Finally, hard commodities are more closely bound to industrial demand and global economic conditions, while soft commodities are more influenced by agricultural conditions and consumer demand.

Are There Commodity ETFs?

Yes. Commodity ETFs provide investors with an easy and convenient way to gain exposure to commodity prices without directly investing in physical commodities or dealing with futures. These ETFs have different types of exposure to the commodity markets; for example, there are physical commodity, futures-based commodity, and commodity producer ETFs, as well as leveraged and inverse commodity ETFs.

What Is Backwardation?

Backwardation is a term used in the commodities futures markets to describe a specific market condition. It occurs when the prices of futures contracts are lower in months further out and in those closer in time. This situation is the opposite of contango, where future prices are higher than current prices.

What Is Contango?

Contango describes a situation when the futures prices of a commodity are higher than the spot or current market price. In a contango market, the price of a futures contract tends to rise as its delivery date approaches.

The Bottom Line

Novice and experienced traders have options for investing in the commodities markets. While commodity futures contracts are the most direct way to participate in price changes in commodities, there are other means for you to invest that have less risk but still have exposure to the specific commodities you have in mind.

In general, commodities are said to be risky because they can be affected by events that are difficult, if not impossible, to predict, such as unusual weather patterns, epidemics, and both natural and human-made disasters.

Reviewed by Chip Stapleton

Most consumers becomem familiar with the travel and tourism industry when they take flights or enjoy family vacations. However, these same activities can also provide investment opportunities, as many tourism companies are publicly traded.

Listed below are five areas of the travel and tourism market that could prove lucrative for investors. It could also help committed travelers better understand the landscape and hunt down some travel deals.

Key Takeaways

• The travel and tourism industry includes companies that provide travel, accommodations, and entertainment to tourists and vacationers.
• Many companies in the tourism industry are traded on public stock exchanges.
• Online travel providers have largely replaced travel agents as the main way to book flights and hotel stays.
• Cruises provide an attractive alternative to some vacationers, providing entertainment, accommodation, and travel as a single package.
• Mega resorts and casinos can also provide an alternative experience to traditional tourism.

Online Travel Providers

As with many industries, revenue continues to shift to the internet when it comes to providing travel and tourism services. Stock brokers have been replaced in large part with online trading platforms, while traditional travel agents have had to compete with online websites that allow consumers to shop for low prices and convenient schedules.

Leading online travel providers include publicly-traded players such as Orbitz, Priceline and Expedia. In particular, Booking Holding’s Priceline has been highly successful in driving traffic to its website to book flights and bid for cheap, last minute travel deals.

Cruising

The cruise line industry has been in existence for more than a century, but still is not that widespread as a travel choice for many consumers. Carnival, the largest cruise line operator in the world, has 157 ships worldwide, with a total capacity of over 400,000 passengers per year.

Capacity is also growing. The global cruise industry has a total capacity of 733,000 in 2023, and it is expected to reach 827,000 by 2027.

1.4 billion

The number of people who travelled internationally in 2024, according to the U.N. World Tourism Organization.

Hotels

The hotel industry is dominated by publicly traded companies like Marriott International, Hilton Worldwide, and Hyatt Hotels. They have largely blanketed their home United States market and are growing internationally. The chains have also pursued managing properties for hotel owners, as well as timeshares that give consumers the right to use their properties for a week, or more, during each calendar year.

Mega Resorts

Large resort operators combine the development of hotels with other entertainment and related amenities. Publicly-traded operators in this space include Ryman Hospitality Group, which owns the Opryland resort in Nashville and other properties in Texas, Florida and Maryland. It specializes in massive resorts that allow big travel groups to host conventions and other giant gatherings.

Vail Resorts owns some of the best-known ski resorts in Colorado and surrounding areas. This includes Vail Mountain, Breckenridge, and Beaver Creek Resort. Of course, The Walt Disney Company specializes in kid-friendly theme parks, hotels, and entertainment complexes, such as Disney World in Florida and Disneyland in California.

Casinos

Las Vegas-style gambling is growing rapidly across Asia. Macao has grown into the largest gambling market in the world and has seen the building of massive casino resorts from Las Vegas-based firms such as Wynn Resorts and Las Vegas Sands. Both are publicly traded companies. This growth is expanding to other parts of Asia, including Singapore, and potentially Vietnam and Japan.

How Profitable Is the Tourism Industry?

International tourism plays an important role in the U.S. economy, as well as the world economy. According to the International Trade Administration, tourism contributes about $2.3 trillion to the U.S. GDP each year, and accounts for 22% of the country’s services exports.

What Is the Biggest Hotel Chain?

Marriott International is the world’s biggest hotel chain in terms of both revenue and profits. In 2024, Marriott reported $25 billion in revenue and $2.4 billion in net income.

What Is the Biggest Tourism Destination for Americans?

Mexico is by far the most frequent destination for U.S. travelers abroad, receiving nearly 40 million Americans each year. Canada is second with 15 million, and European countries like the United Kingdom, France, and Italy account for over 3 million each.

The Bottom Line

These are just some of the many opportunities to invest in the travel and tourism industries across the world. Overseas growth, especially in emerging market economies, should continue to outpace that in more developed markets in North America and Europe. However, as with the online travel space, there will always be pockets that are picking up market share in every part of the world.

Reviewed by Margaret James
Fact checked by Charles Heller

Financial ratios are calculations that compare two (or more) pieces of financial data that are normally found in a company’s financial statements.

Ratios can be invaluable to investors making decisions about companies in which they might want to invest because they can present perspectives of a company’s financial performance and well-being from different standpoints.

A variety of ratios is used by individual investors, institutional investors, and professional analysts. Typically, financial ratios are organized into four categories: 

• Profitability ratios
• Liquidity ratios
• Solvency ratios
• Valuation ratios or multiples

Generally, ratios are used in combination to gain a fuller picture of a company.

Using a particular ratio as a comparison tool for more than one company can shed light on the less risky or more attractive.

Additionally, an investor can compare a ratio derived from certain data today to the same ratio derived from a long period of historical data. This can provide them with a view of long-term performance.

Investors can put ratios to use in different ways. All in all, financial ratios can provide a comprehensive view of a company from different angles and help investors spot potential red flags.

In this article, we’ll look at each ratio category, some formulas, and some essential explanations.

Key Takeaways

• Ratios—one variable divided by another—are financial analysis tools that show how companies are performing in their own right and relative to one another.
• Financial ratios can be computed using data found in financial statements such as the balance sheet and income statement.
• In general, there are four categories of ratio analysis: profitability, liquidity, solvency, and valuation.
• Common ratios include the price-to-earnings (P/E) ratio, net profit margin, and debt-to-equity (D/E).
• Financial ratios are essential to solid fundamental analysis.

Profitability Ratios

Profitability is a key aspect to analyze when considering an investment in a company. This is because high revenues alone don’t necessarily translate into high earnings or high dividends.

Essentially, profitability analysis seeks to determine whether a company will make a profit. It examines business productivity from multiple angles using a few different scenarios.

Profitability ratios use data from a specific point in time to provide insight into how much profit a company generates and how that profit relates to other important information about the company.

These ratios are used to assess a business’ ability to generate earnings relative to its revenue, operating costs, assets, and shareholders’ equity over time.

Some key profitability ratios include:

• Gross margin (and adjusted gross margin)
• Operating margin 
• Net profit margin
• EBITDA margin
• Operating cash flow margin
• Return on assets (ROA)
• Return on equity (ROE)
• Return on invested capital (ROIC)
• Return on investment (ROI)

One of the leading ratios used by investors for a quick check of profitability is the net profit margin.

Example: Net Profit Margin

$text{Profit Margin}=frac{text{Net Income}}{text{Revenue}}$Profit Margin=RevenueNet Income​

This ratio compares a company’s net income to its revenue. In general, the higher a company’s profit margin, the better. A net profit margin of 1, or 100%, means a company is converting all of its revenue to net income.

Profit margin levels vary across industries and time periods. Thus, it is helpful to look at a company’s net profit margin versus the industry and the company’s historical average.

With net profit margin, there can be a few red flags to watch out for. For instance, a company that has decreasing net profit margins year-over-year could be dealing with changing market conditions, increasing competition, or rising costs.

A company with a very low profit margin may need to focus on decreasing expenses through wide-scale strategic initiatives.

A high net profit margin relative to the industry may indicate a significant advantage in economies of scale, or, potentially, some accounting schemes that may not be sustainable for the long term.

Liquidity Ratios

Liquidity relates to how quickly and reliably a company can pay its obligations and debts. It indicates how well company assets cover expenses.

Liquidity ratios give investors an idea of a company’s operational efficiency. They also show how quickly and easily a company can generate cash to purchase additional assets or to repay creditors. This need can arise in an emergency situation or in the normal course of business.

Some key liquidity ratios include:

• Current ratio
• Quick ratio
• Cash ratio
• Cash conversion cycle (CCC)
• Operating cash flow ratio
• Receivables turnover
• Inventory turnover
• Working capital turnover

Example: Current and Quick Ratios

The current and quick ratios are great ways to assess the liquidity of a firm. The ratios are similar.

The current ratio is calculated by dividing current assets by current liabilities. Since current assets and current liabilities represent activity in the upcoming 12 months, this ratio can provide insight into the firm’s short-term liquidity.

A higher current ratio is favorable as it represents the number of times current assets can cover current liabilities. However, one that’s too high might indicate that a company isn’t utilizing its excess cash as well as it could to pursue growth.

The quick ratio differs slightly. Its calculation subtracts inventory from current assets before they’re divided by current liabilities. This ratio can present better insight into the short-term liquidity of the firm because of the exclusion of inventory.

A higher quick ratio indicates more short-term liquidity and good financial health.

Both of the formulas below provide the same result. You can choose which to use based on the information presented on the financial statement that you’re reviewing.

Tip

It’s important to understand the variables that are behind ratios. That’s because a company’s executive or management team has the flexibility to, at times, alter its strategies to make a company’s ratios and stock appear more attractive. So, understanding the data will help you “see through the smoke.”

Solvency Ratios

Solvency ratios, also known as leverage ratios, are used by investors to see how well a company can deal with its long-term financial obligations.

As you might expect, a company weighed down with debt is probably a less favorable investment than one with a minimal amount of debt.

Some popular solvency ratios include:

• Debt-to-total-assets
• Debt-to-equity
• Time interest earned
• Interest coverage ratio
• Net income to liabilities
• Times interest earned 

Debt-to-assets and debt-to-equity are two ratios often used for a quick check of a company’s debt levels. They show how debt stacks up against the categories of assets and equity on the balance sheet. They give investors an idea of a company’s financial health as it relates to a potential burden of debt.

Example: Debt-to-Assets

The total-debt-to-total-assets ratio is used to determine how much of a company is financed by debt rather than shareholder equity.

It is calculated as follows:

$begin{aligned}&text{Total Debt to Total Assets} = frac{text{STD} + text{LTD}}{text{Total Assets}}\&textbf{where:}\&text{STD}=text{short term debt}\&text{LTD}=text{long term debt}end{aligned}$​Total Debt to Total Assets = Total AssetsSTD + LTD​where:STD=short term debtLTD=long term debt​

A smaller percentage is better because it means that a company carries a smaller amount of debt compared to the amount of its total assets. The greater the percentage of assets, the better a company’s solvency.

Remember, lenders typically have the first claim on a company’s assets if it’s required to liquidate. A lower debt-to-assets ratio typically indicates less risk.

When using this ratio to analyze a company, it can help to look at both the company growth phase and the industry as a whole.

It’s not unrealistic for a younger company to have a high debt-to-total-assets ratio (with more of its assets financed by debt) as it hasn’t had a chance to eliminate its debt.

Valuation Ratios

Valuation ratios are often referred to by the media. They’re used to analyze the attractiveness of a potential investment in a company.

These metrics primarily incorporate the price of a company’s publicly traded stock. They can help investors understand how inexpensive or expensive a stock is relative to the market.

In general, the lower the ratio level, the more attractive an investment in a company becomes. Often, analysts will take the reciprocal of a valuation ratio, or its multiple, as a measure of relative value.

Some popular valuation multiples include:

• Price-to-earnings
• Price-to-book
• Price-to-sales
• Price-to-cash flow

Example: Price-to-Earnings

The price-to-earnings (P/E) ratio is a well-known valuation ratio. It compares a company’s stock price to its earnings per-share. It can help investors determine a stock’s potential for growth. In addition, the P/E ratio can signal whether a stock is undervalued or overvalued.

The P/E ratio is calculated as follows:

$text{Price to Earnings} = frac{text{Market Value Per Share}}{text{Earnings Per Share (EPS)}}$Price to Earnings=Earnings Per Share (EPS)Market Value Per Share​

Basically, the P/E tells you how much investors are willing to pay for $1 of earnings in a company. So, a higher ratio indicates that investors are expecting higher earnings growth.

Investors often prefer a lower P/E because they’d have to spend less money for each dollar of earnings.

It should be clear that investors have to compare the ratio they calculate to the same ratio for other companies in the same industry, or to the industry average, to get an idea of what’s higher or lower.

Why Do Investors Use Financial Ratios?

Financial ratios are a great way to gain an understanding of a company’s potential for success. They can present different views of a company’s performance. It’s a good idea to use a variety of ratios, rather than just one, to draw comprehensive conclusions about potential investments. These ratios, plus other information gleaned from additional research, can help investors to decide whether or not to make an investment.

How Do Ratios Work As a Comparison Tool?

An investor can look at the same ratios for different companies to winnow down a list of possible investments. Or, one might compare ratios for one or more companies to the same ratio for the industry average. Finally, it can be eye-opening to compare a ratio calculated recently to the same ratio calculated over time for a single company to get a historical perspective of performance. You might also compare historical perspectives of ratios for various companies.

What Do Liquidity Ratios Show?

Liquidity ratios provide a view of a company’s short-term liquidity (its ability to pay bills that are due within a year). They are one way to size up a company’s financial well-being. For instance, a positive current ratio is a good sign. It means that a company has enough in current assets to pay for current liabilities.

On the other hand, a current ratio that’s too high can indicate that a company may not be using its excess cash as effectively as it could be. Investors should ask themselves, is too much cash available that could be used to improve performance? Should more of the current assets indicated by a high ratio be invested to drive growth?

The Bottom Line

Financial ratios can be used to compare companies as prospective investments. They can help investors evaluate stocks within an industry. Moreover, they can provide a measure of a company today that can be compared to its historical data.

The information you need to calculate ratios is easy to come by. Every figure can be found in a company’s financial statements. Once you have the raw data, you can plug it into your financial analysis tools and put it to work for your benefit.

Sometimes, new investors avoid financial ratios because they don’t know how to interpret them or use them. So take the time to understand what financial ratios tell you and how to calculate them. Doing so can help you gain greater confidence in your investment decisions and avoid investment mistakes.

Reviewed by Somer Anderson

Absolute P/E Ratio vs. Relative P/E Ratio: An Overview

The absolute and relative P/E ratios are metrics to determine if a company is over or undervalued. The simple answer to this question is that absolute P/E is the price of a stock divided by the company’s earnings per share (EPS). This is the more common measure, and it indicates how much investors are willing to pay per dollar of earnings.

The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let’s look at both absolute and relative P/E in more detail.

Key Takeaways

• The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
• Analysts may make a distinction between absolute P/E and relative P/E ratios in their analysis.
• Absolute P/E is the current price-to-earnings calculated as usual. Relative P/E compares that to some benchmark or a range of past P/Es, say over the past 10 years. 

Absolute P/E Ratio

The numerator of this ratio is usually the current stock price, and the denominator may be the trailing EPS (from the trailing 12 months [TTM]), the estimated EPS for the next 12 months (forward P/E) or a mix of the trailing EPS of the last two quarters and the forward P/E for the next two quarters.

When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current time period. For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).

Relative P/E Ratio

Relative P/E compares the current absolute P/E to a benchmark or a range of past P/Es over a relevant time period, such as the last 10 years. Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached. Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.

The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past is high or low). If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

Important

When calculating a company’s earnings per share, it is important to use the diluted EPS, not the basic EPS.

Example of Absolute vs. Relative P/E Ratio

Suppose that a company’s shares are currently trading for $100, and the company reports $4 of earnings per share. The company’s absolute P/E ratio is 25, meaning that shareholders pay $25 for every $1 of earnings. This is the P/E ratio that is usually reported on stock screeners or company summaries.

But stock analysts may wish to examine how the company’s absolute P/E ratio has changed over time, or how it compares with the industry at large. Suppose that the company’s P/E ratio has ranged from 15 to 40 over the past ten years. If the current (absolute) P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).

These values tell investors that the company’s current P/E is 62.5% of the 10-year high, and 67% higher than the 10-year low.

Special Considerations

If all is equal over a given time period, a P/E ratio that is close to its historical high could be a sign that the stock is overvalued. However, there is a lot of discretion that goes into interpreting relative P/E. Fundamental shifts in the company, such as a major acquisition, can justifiably raise the P/E above the historic high.

Relative P/E may also compare the current P/E to the average P/E of a benchmark such as the S&P 500. Continuing with the example above, suppose the average P/E ratio in the S&P 500 is 20. The relative P/E of the company to the index is therefore 1.25 (25/20).

This shows investors that the company has a higher P/E relative to the benchmmark, indicating that the company’s earnings are more expensive than those of other companies in the index.

A higher P/E, however, does not necessarily mean it is a bad investment. On the contrary, it may mean the company’s earnings are growing faster than those of other companies in the index. If there is a large discrepancy between the company’s P/E ratio and the P/E of the index, investors may want to do additional research into the discrepancy.

What Does the P/E Ratio Tell You?

The price-to-earnings ratio, or P/E, reflects the share price of a company relative to its actual profits, reflected in the company’s reported earnings. This tells investors whether the share price is relatively high or low, compared with other companies. A low P/E ratio indicates that a company could be a bargain investment, while a high P/E ratio suggests that the company may be overvalued. Different industries have different profit margins, so investors should be careful to compare P/E ratios across similar companies.

Is It Better for a P/E Ratio to Be Higher or Lower?

Value investors typically look for stocks with a low P/E ratio, as that indicates that the share price is low relative to the company’s earnings. That could be because that stock is undervalued in the market; however, it is also possible for a company to have a low share price due to news events or unfavorable market conditions.

What Does a Negative P/E Ratio Mean?

A negative price-to-earnings (P/E) ratio means that the stock has reported negative earnings—in other words, it is losing money. Although that’s generally a bad sign, it’s not uncommon for otherwise-successful companies to lose money if they go through a temporary rough patch, or if they focus on reinvesting their revenue for future growth.

The Bottom Line

Absolute P/E, compared to relative P/E, is the most often used measure and is useful in investment decision-making. However, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.

Fact checked by Katrina Munichiello
Reviewed by Andy Smith

Apple Business Model vs. Microsoft Business Model: An Overview

More than any other American companies, Apple, Inc. (NASDAQ: AAPL) and Microsoft Corporation (NASDAQ: MSFT) dominate the intersection of technology and consumer access. Even though they compete across a huge range of sub-industries, such as computing software, hardware, operating systems, mobile devices, advertising, applications, and web browsing, each firm primarily targets different markets.

On Feb. 15, 2025, AAPL had a market cap of around $3.6 trillion. Microsoft lagged behind it at $3.04 trillion.

Key Takeaways

• As of 2025, Apple and Microsoft are two of the biggest companies in the world, alternating the title of the world’s most valuable company.
• Both companies have market caps of over $3 trillion.
• Apple’s business model targets small and medium sized businesses, and consumers with devices targeted toward them. They are able to keep their base due to easy-to-use designs and data migration to new product lines.
• Microsoft is an innovative leader in cloud computing, professional and business solutions, with a lower focus on personal computing than it used to have.

The Apple Business Model

It is difficult to recall a modern American business so thoroughly dominated by the ideas and personality of one individual as Apple was under Steve Jobs. Jobs’ remarkable innovations propelled Apple to unprecedented heights until his passing in 2011.

During Steve Jobs’ second reign—he was fired in 1985 and returned in 1997—Apple returned to relevancy and revolutionized multiple subindustries. In 2001, the company released the iPod, a pocket-sized device that could hold 1,000 songs, which soon took over the Sony Walkman. In 2007, Apple completely redefined mobile phones when the iPhone was released.

Apple easily bests its competitors in terms of hardware sales and high-end gadgets. Thanks to the company’s early 2000s reputation as a nonconformist response to Microsoft, millennials grew up using Macs in large numbers. This is buoyed by the company’s brilliant insistence on integrating its products, making it easier to keep using new Apple products and thus more difficult to switch to a competitor’s interface; this is sometimes referred to as the “Apple Ecosystem Lock.”

The weakness in the Apple’s business model lies in the historic success of the company’s golden invention: the iPhone. Nearly half of all Apple revenue comes from iPhone sales, and no comparable innovation has taken off since its former CEO died.

However, CEO Tim Cook continued driving improvements and innovations to existing products and services. In 2023, new iOS 18, MacBook Pro and Air Models, iPad Air and Pro models, the iPhone 16 variants, the Apple Watch series, and AirPods 4 were all launched.

The iPhone remained Apple’s key revenue generator in 2024, with sales of $201.18 billion out of $391.04 billion over the year (51%). Apple’s services generated $96.2 billion in sales.

The Microsoft Business Model

For years, Microsoft dominated the computer industry with its Windows software; Apple was an afterthought for more than a generation of operating products. Before Google Web browsing began to dominate the market, Microsoft gave away Internet Explorer for free, driving Netscape and other similar companies out of business.

The Microsoft revenue model historically relied on just a few key strengths. The first, and most important, was the licensing fees charged for use of the Windows operating system and the Microsoft Office suite.

However, technological developments have made its operating system less of a revenue generator. Microsoft has moved its Office suite to an online subscription service to generate recurring revenue, acquired LinkedIn and its subscription and sales solutions, and developed cloud-based solutions for businesses and developers that generate recurring revenues. Its primary revenue generator was server products and cloud services, which generated $97.7 billion in FY 2024. This was followed by office products and cloud services, with $54.9 billion generated. Windows was third, generating $23.24 billion.

Microsoft has a popular gaming console and associated services that Apple does not—the Xbox and its subscription services. Gaming and gaming services accounted for the fourth largest revenue stream for Microsoft in 2024, $21.5 billion.

Is Microsoft Doing Better Than Apple?

Each company has transitioned to focus on different products and services, so they each rank well. However, Apple generated more returns for investors as of February 2025 (33.23% year-over-year), while Microsoft lagged at 0.07%. Microsoft generated $245.12 billion in revenue in 2024, while Apple generated 391.04 billion. Microsoft earned $88.14 billion in net income to Apple’s $93.74 billion. It seems Apple did slightly better (as far as finances go) than Microsoft in 2024.

Which Is Best, Microsoft or Apple?

That depends on what you’re evaluating. They each have different products and services and are very successful.

Who Won the Apple vs. Microsoft Lawsuit?

The copyright infringement lawsuit between Apple and Microsoft ended in 1992 in favor of Microsoft. Apple sued Microsoft for violating a copyright it held on certain elements of graphic user interfaces.

The Bottom Line

Apple and Microsoft are two tech giants that have dominated their industry for many years. Each began with similar business models but eventually went in different directions, with Microsoft catering more to productivity, business solutions, and cloud computing while keeping many of its consumer-facing products and services. Apple continues to market mostly to consumers and small- and mid-sized businesses.

Fact checked by Suzanne Kvilhaug
Reviewed by Chip Stapleton

You can use the trading activity of corporate insiders and large institutional investors to learn more about a stock. Insider or institutional activity should not be considered a buy or sell signal, but it gives you another tool to add to your stock evaluation toolbox.

Here is how to access insider and institutional ownership information and evaluate what it might mean for a stock you’re considering.

Key Takeaways

• A company’s officers, directors, relatives, or anyone else with access to key company information are considered insiders.
• A company’s proxy statement, Form DEF 14A, is the statement that lists directors and officers and the number of shares they each own.
• Schedules 13D and 13G are filed by companies to disclose beneficial ownership information, which is defined as more than 5% of a company’s stock issue.
• Forms 3, 4, and 5 are filed by stockholders to disclose insider beneficial ownership when they have more than 10% of voting power.

Insider Ownership

Insiders are a company’s officers, directors, relatives, or anyone with access to key company information before it’s made available to the public. If you pay attention to what insiders do with company shares, you might catch them making decisions because they have a better picture of the company’s future than those outside of it. You’ll be able to make reasonable assumptions about the company when comparing published information with share sales or purchases.

Since insider ownership and trading can impact share prices, the Securities and Exchange Commission (SEC) requires companies to file reports on these matters, allowing you to take advantage of any changes.

Important

An insider trade can be legal or illegal depending on when it is made—it becomes illegal if information behind the trade is not public.

Where to Find Insider Trading Information

You can retrieve forms from the SEC’s EDGAR database or the SEC Insider Transaction Data Sets. The most relevant forms that help you see what insiders are doing are Forms 3, 4, 5, Form DEF 14A, Form 13D, and 13G.

Form DEF 14A

This form is also known as the Definitive Proxy Statement. An SEC requirement for publicly traded companies, Form DEF 14A, must be filed ahead of shareholders’ meetings or whenever a shareholder vote is required. This statement includes a list of items being put to a vote as well as a list of directors and officers, along with the number of shares they each own.

This form also lists beneficial owners—people or entities owning more than 5% of a company’s stock—along with other pertinent information like board member nominations, as well as executive compensation.

Schedules 13D and 13G

Schedule 13D and Schedule 13G are also relevant forms that disclose beneficial ownership information. Here is a brief description of each form:

• Schedule 13D: This form is also known as the Beneficial Ownership Report. Anyone who owns more than 5% of a company’s stock must file Form 13D with the SEC within 10 days of a stock acquisition. The form must also include the reason behind the stock acquisition—whether it’s a merger, company acquisition, or takeover. Other information on this form includes the owner’s identity and the source of the funds for the transaction. Owners who acquire more than 20% of a company’s share must automatically file a Form 13D.
• Schedule 13G: Just like Schedule 13D, this form lets the public know about anyone who owns more than 5% of a company’s total stock. However, it’s shorter than the 13D because it requires much less information.

Forms 3, 4, and 5

Forms 3, 4, and 5 are filed to disclose insider beneficial ownership when shareholders have more than 10% of voting power. Forms are filed at different stages of stock acquisition.

Individuals file Form 3 when they first acquire shares. This form is also known as the Initial Statement of Beneficial Ownership of Securities. Form 3 helps the SEC track initial ownership along with whether there is any suspicious activity going on.

Form 4 is also referred to as the Statement of Changes in Beneficial Ownership. This form is used to report any changes of ownership of insiders who hold more than 10% of a company’s stock. Part of the reporting includes the shareholder’s relationship to the company.

Also known as the Annual Statement of Changes in Beneficial Ownership, Form 5 is an annual snapshot of holdings. Insider trading must be filed electronically through the EDGAR system within two days of the transaction, giving outside investors reasonably up-to-date ownership information.

Interpreting Insider Reports

High insider ownership typically signals confidence in a company’s prospects and ownership in its shares. This, in turn, gives the company’s management an incentive to make the company profitable and maximize shareholder value.

However, a company can have too much insider ownership. When insiders gain corporate control, management may not feel responsible to shareholders and, instead, to themselves. This frequently occurs in companies that issue multiple classes of stock, which means one class carries more voting power than another.

For example, Google’s much-publicized initial public offering (IPO) in the fall of 2004 was criticized for issuing a special class of super-voting shares to certain company executives. Critics of the dual-class share structure contend that, should managers yield less than satisfactory results, they are less likely to be replaced because they possess 10 times the voting power of normal shareholders.

While insider buying is usually a good sign, don’t be alarmed by insider selling, unless there is a lot of it. Insiders tend to buy because they have positive expectations, but they may sell for reasons independent of their expectations for the company.

Which Insiders to Watch

It’s important to know which insiders to watch. Clusters of activity by several insiders might indicate something is up. If a company has more than one instance of similar insider trading over a short period, there’s a sign of a consensus of insider opinion. Large transactions also mean more than small trades.

Insiders with track records of Form 4 activity should be watched more closely than those with little or poor records—there is something going on within the company. The most telling trading activity comes from top executives with the best insights into the company, so look for transactions by CEOs and CFOs.

Finally, be careful about placing too much stake in insider trading since the documents reporting them can be hard to interpret. Additionally, the activity might not mean much. Many Form 4 trades do not represent buying and selling that relate to future stock performance. The exercise of stock options, for instance, shows up as both a buy and a sell on Form 4 documents, so it is a dubious signal to follow.

Automatic trading is another activity that is hard to interpret. To protect themselves from lawsuits, insiders set up guidelines for buying and selling, leaving the execution to someone else. SEC Form 4 documents disclose these hands-off insider transactions, but they don’t always state that the sales were scheduled far ahead of time.

Institutional Ownership

Organizations that control a lot of money—mutual funds, pension funds, or insurance companies—and which buy securities are referred to as institutional investors. These entities own shares on behalf of their clients and are generally believed to be the force behind supply and demand in the market.

The Debate Over the Implications

Whether institutional ownership in a stock is a good thing remains a matter of debate. Peter Lynch, in his best-seller One Up on Wall Street, lists the 13 characteristics of the perfect stock. One of them is this: “Institutions don’t own it and the analysts don’t follow it.” Lynch favors stocks that the big investment groups overlook because they have more of a chance of being undervalued. Lynch argues that companies whose stock is owned by institutional investors are fairly valued, if not overvalued.

William O’Neil, founder of Investor’s Business Daily, on the other hand, argues that it takes a significant amount of demand to move a share price up, and the largest source of demand for stocks is institutional investors. O’Neil reckons that if a stock has no institutional owners, it’s because they have already seen it and rejected it. In his book How to Make Money in Stocks, O’Neil has institutional sponsorship as the sixth characteristic to look for in stocks worth buying.

O’Neil and Lynch both agree that institutional ownership can be dangerous. These big institutions move in and out of positions in very large blocks, so they cannot buy or sell holdings gracefully. If something is perceived as going wrong with a company and all its big owners sell en masse, the stock’s value will plunge.

Although there are mutual funds that operate with longer-term horizons, and pension funds tend to be long-term stockholders, institutional investors tend to react to short-term events. The high correlation between high institutional ownership and stock price volatility is a fact of life in investing, and so it pays to know what the institutions are up to and whether a stock you are interested in already has a large institutional interest.

Where to Find Holdings Information

Institutional investment managers who exercise investment discretion of more than $100 million in securities must report their holdings on Form 13F with the SEC. This form is filed quarterly by institutional investment managers who have a minimum of $100 million in assets under management (AUM) within 45 days of the end of a quarter. Again, you can search for and retrieve Form 13F filings using the SEC’s EDGAR database. Yahoo Finance also provides a very useful site that details stock ownership. To view this, search Yahoo Finance for a particular company and click the section labeled “Holders” to receive details on the company’s institutional holders.

Is Institutional Ownership Good for a Stock?

Institutional ownership is believed to be essential for stock values. Institutions own most of the stocks on the market, provide liquidity, and influence retail investing. They also make it easier for retail investors to access the markets. However, institutions do pose a danger to investors if they transact in large blocks, which can unduly influence prices.

Is Insider Ownership Good for a Stock?

Generally, insider ownership is good because it indicates that those working in the company believe in its prospects.

How to Check Institutional Ownership of a Stock?

The easiest way is to visit Yahoo Finance, select the company you want to research, and click “Holders” on the left. The resulting page will tell you what percentage of shares are held by institutions and insiders and give you a list of the top institutional holders.

The Bottom Line

Institutions tend to be smart, diligent, and sophisticated investors, and insiders have the best understanding of a company’s prospects, so their ownership is a good criterion for a first screen in your research or a reliable confirmation of your analysis of a stock. However, as with all fundamental analysis considerations, insider and institutional trading should be used in conjunction with several other factors.

Fact checked by Katrina Munichiello
Reviewed by Khadija Khartit

Financial risk is inherent in any business enterprise, and good risk management is an essential aspect of running a successful business.

There are different ways to categorize a company’s financial risks. For example, managers can separate financial risk into four broad categories: market risk, credit risk, liquidity risk, and operational risk.

A company’s management can control risk with varying levels of success. Some risks can be directly managed; other risks are largely beyond the control of management.

Sometimes, the best a company can do is to try to anticipate possible risks, assess the potential impact on the company’s business, and be prepared with a plan to react to adverse events.

Key Takeaways

• There are four broad categories of financial risk that companies can address with proper risk management measures.
• Market risk is the risk that there could be a substantial change in the particular marketplace in which a company competes.
• Credit risk arises when companies extend their customers a line of credit, or, when a company can’t pay for services provided on credit by a vendor.
• Liquidity risk refers to how easily a company can convert its assets into cash if it needs funds; it also refers to its daily cash flow.
• Operational risks emerge as a result of a company’s regular business activities and include fraud, lawsuits, and personnel issues.

1. Market Risk

For businesses, market risk can relate to changing conditions in the specific marketplace in which it competes.

Changing Consumer Preferences

One example of market risk is the increase in consumers who prefer shopping online. This aspect of market risk has presented significant challenges to traditional retail businesses.

Many companies that have adapted to serving an online shopping public have thrived and seen substantial revenue growth, while other companies that couldn’t adapt, have been slow to adapt, or have made bad decisions relating to the changing marketplace have fallen by the wayside.

Another trend is ESG (environmental, social, and governance business practices). Some companies are now pressured by customers to move from polluting industries to cleaner ones. Or from seeking profits for profits’ sake only to seeking profits while doing good in communities.

Companies who lag behind this trend could be at risk for being poor in capital, short in talent, and unfortunate in branding.

Agility of Competitors

Another element of market risk is the risk of being outmaneuvered by competitors.

The global marketplace is increasingly competitive, often with narrowing profit margins. The most financially successful companies are those that offer a unique value proposition that makes them stand out from the crowd with a solid marketplace identity.

Note

Market risk can also relate to the risk of loss due to changing product prices, stock prices, currency rates, and interest rates.

2. Credit Risk

Businesses face credit risk when they extend credit to customers, essentially allowing them to make purchases without immediate payment.

As long as customers who buy on credit pay their bills, the company avoids loss. If they default on payments, then the company has a problem.

Credit risk can also refer to the company’s credit line with suppliers. A company must ensure that it always has sufficient cash flow to pay its accounts payable bills in a timely fashion.

Otherwise, suppliers may either stop extending credit to the company or even stop doing business with the company altogether.

Important

While managing risk is an important part of running a business effectively, a company’s management only has so much control. In some cases, the best thing management can do is to anticipate and prepare for potential risks.

3. Liquidity Risk

Liquidity risk involves asset liquidity and operational funding liquidity.

Asset liquidity refers to the ease and speed with which a company can convert its assets into cash should there be a sudden, substantial need for additional cash flow.

Operational funding liquidity refers to the amount of daily cash flow being enough to meet short-term liabilities and obligations, and keep the business running smoothly.

General or seasonal downturns in revenue can present a substantial risk if the company suddenly finds itself without enough cash on hand to pay the basic expenses—salaries, vendor bills—necessary to continue to function.

This is why cash flow management is critical to business success—and why analysts and investors look at metrics such as free cash flow when evaluating companies as an equity investment.

4. Operational Risk

Operational risks are the various risks that can arise from a company’s ordinary business activities. The operational risk category includes lawsuits, fraud, and personnel problems.

It also involves business model risk, which is the risk that a company’s models of marketing and growth plans may prove to be inaccurate or inadequate.

With All the Inherent Risks, Why Do People Start Businesses?

People start businesses when they fervently believe in their core ideas, their potential to meet unmet demand, their potential for success, profits, and wealth, and their ability to overcome risks. Many businesses believe that their products or services will contribute to the good of their community or society at large. Ultimately (and even though many businesses fail), starting a business is worth the risks for some people.

What Is Financial Risk?

Broadly speaking, financial risk is the risk that a business could lose money on an investment it makes or due to its decisions about its operations, its borrowing, or its market (including competitors).

Is Managing Risk a Big Part of Business?

Yes, it’s a crucial and essential effort that businesses make so that they may prevent financial loss. Many businesses employ individuals whose sole job is identifying and mitigating risk. Large companies in particular staff entire departments devoted to risk management.

The Bottom Line

All businesses face different forms of risk. Risk is built in when starting and running a business, and as a company makes moves to achieve lasting success.

Normally, businesses can’t avoid risk but they can manage and reduce it.

Four broad categories of financial risk for businesses are market risk, credit risk, liquidity risk, and operational risk.