Warren Buffett reveals the hidden dangers of low-priced stocks

Warren Buffett is famous for saying that risk Volatility is not permanent, it is the possibility of permanent loss. In a letter to shareholders, he offered a compelling corollary: When a stock’s price falls sharply, it doesn’t always indicate value — it may also indicate that the stock is riskier than before.

His observation turns a common investor intuition on its head: If a stock is “on sale,” shouldn’t it be safer? According to Buffett, a deal that appears cheap may actually carry hidden risks that were not more apparent at a higher price.

How does Buffett measure risk?

Academics often define risk mathematically, using a stock’s “beta,” which measures how much a stock price moves relative to the broader stock market. Under the prevailing framework, a stock that is falling looks riskier on paper precisely because its price fluctuates more than the price of the S&P 500.

Buffett described this view as “completely wrong.” His view, as a value investor, is that when certain stocks are offered at a fraction of their previous value, a lower price can make them a better deal. “Price is what you pay, value is what you get…I like to buy quality goods when they are low.” In other words, if the intrinsic value does not change much, a decrease in price expands your margin of safety.

But he also warned that not every sharp decline indicates a deal. Sometimes, a low price reflects serious and lasting problems, such as shrinking profits or a company that is so heavily indebted that it cannot recover. That’s why a sudden drop in stock price can increase risk: it may reveal management problems, competitive pressures, or a balance sheet with too much borrowing to weather bad times. In these cases, a lower level is not safer; It’s a red flag.

Although it may seem contradictory, Buffett’s position is consistent: he views risk as being related to the actual qualities of a business and its intrinsic value rather than to market fluctuations. The lower the price relative to the value, the less room for error you have.

How a sharp decline increases risk

Buffett isn’t saying prices will fall always risky. But it can become dangerous in at least three cases:

1. When companies are in financial troubleWhen a business is under severe pressure, its profits and future income are in doubt. If profits decline, paying off debt becomes more difficult, and the company has less room to maneuver. In this scenario, shareholders are the last to receive their paychecks. This means that if things go wrong, they are the ones who lose the most. At low stock prices, there is often little protection left, and shareholders are more vulnerable to the company going bankrupt or needing major restructuring.
2. When it becomes difficult to sell stocks: Cheap stocks tend to attract less interest, which is why the price falls. The buyer base is dwindling. The gap between buyers’ offers and what sellers want is widening. It can become more difficult to exit a trade without pushing the price down further. A further decline may occur, especially in illiquid conditions – that is, when only a few people are trading the stock. Therefore, the liquidity ‘risk premium’ rises when prices fall, meaning you may be stuck holding the stock or forced to accept a price that is too low.
3. Negative feedback loops: Once a stock declines sharply, it can enter a self-reinforcing loop. Weak investor confidence causes them to demand higher returns for taking risks, which in turn leads to more selling, leading to lower valuation. In that environment, a company that may have been “safe enough” at a higher price could be severely punished when revalued under more demanding investor expectations.

Bottom line

Buffett’s statement about a stock becoming “riskier” at a lower price is a criticism of academic views, not a celebration of knives falling. Lower prices can reduce risk when the underlying business is still strong and the investor is not using borrowed money, is patient, and thinks like an owner. But low rates increase the risk when debt and declining economies turn a temporary cut into a permanent loss of your money.

For long-term investors, the job is to judge value, keep cash on hand, and use volatility as an ally — not let a statistical measure determine risk for you.