Speculation Versus Investment
The margin of safety idea conceived by Ben Graham is a concept dealing with sound investing. Value investing, and other prudent investing strategies, must be understood in contrast to speculating. At its heart, identifying a margin of safety in a common stock is first about identifying the company’s intrinsic business value. Although margin of safety relates to, and with a low stock price, it is not the price per se but the valuation that it represents that is most important. Once again, I will turn to Ben Graham’s teachings from The Intelligent Investor with two important excerpts that summarize my points.
“Margin of Safety” as the Central Concept of Investment
It is our argument that a sufficiently low price can turn a security of mediocre quality into a sound investment opportunity— provided that the buyer is informed and experienced and that he practices adequate diversification. For, if the price is low enough to create a substantial margin of safety, the security thereby meets our criterion of investment.” Page 521 The Intelligent Investor
“To Sum Up
Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings. Yet every corporate security may best be viewed, in the first instance, as an ownership interest in, or a claim against, a specific business enterprise. And if a person sets out to make profits from security purchases and sales, he is embarking on a business venture of his own, which must be run in accordance with accepted business principles if it is to have a chance of success.
The first and most obvious of these principles is, “Know what you are doing—know your business.” Page 523 The Intelligent Investor
Summary and Conclusions
Investing in common stocks is fraught with danger, complexity and confusion. Therefore, anything that can reduce the risks associated with successfully building and executing a stock portfolio is of great benefit. Personally, I do believe that Ben Graham’s margin of safety motto is one of the most important investing principles to keep in the forefront of our minds. Finding stocks with great margins of safety does require some work and digging. However, I believe the rewards are more than worth the effort.
Finally, it’s important to recognize and understand that finding stocks when they offer a margin of safety is a long-term strategy. For whatever reason, when a stock offers a margin of safety, it is unpopular. Therefore, logic would dictate that it may not provide immediate gratification. However, over the long-term, which I define as at a minimum business cycle of three to five years, a stock providing a margin of safety will lower risk and increase long-term returns. This is especially important for retired investors or those near retirement.
Disclosure: Long AFL, LKQ, CTSH, DE< TEVA, CVX at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
