APPROACH TO RISK-RETURN ESTIMATION IN COMMON STOCKS INVESTMENT

Ever since the wall came down most emerging market economies have been pushing hard to get closer to something that represents their ultimate goal – the market driven economy. Despite the hype and optimism that sprung up following the early victories in their quest to reach their goal, many more changes in the political, social and business world still await to be completed. Perhaps, the toughest change must be made in the way the economy and their political and business leaders appreciafe the “nuts and bolts” of capitalism. Croatia is not an exception to this problem either. While issues like privatization, banking system and restructuring certainly fill out front pages more easily, it is the fundamental concepts like risk and return that underlie the big picture of market economy. How does one value companies and securities, choose among different investment projects and evaluate executive performance if he does not know their risk- return properties? It is surprising to see then how foreign these fundamentals still are to a great number of Croatian executives. Unfortunately, in a market economy business decisions based on a gut feeling or a ballpark figure frequently end up in disaster. This article discusses the concept of the risk-return relationship and how to quantify it. Then it explains the rationale behind a different approach to analyzing risk and return and the interpretation of the results. The major part is aimed at explaining the risk of common stocks and an example of the key computations is shown based on recent public information for two leading Croatian companies. It must be pointed out that this article has by no means covered all the issues related to this topic nor has it tried to present a critique of all current problems which obstruct risk- return estimation in the Croatian market today.