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It’s Only ‘Safety First’ That Will Make You Money: Part I

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vault doorBillionaire investor Warren Buffett, on the heels of releasing his annual report, said, Monday, that the stock market isn’t in a bubble and “measured against interest rates, stocks actually are on the cheap side compared to historic valuations.” In the same interview, he also warned “That doesn’t mean the stock market can’t go down 20% tomorrow.” A buying opportunity he’d welcome with open arms. It’s good to be Warren.

It’s funny how life works because, coincidentally, later that day I was speaking with clients who live in the Laguna Beach area. As we got to talking about how crazy the real estate market is, they said Warren Buffett is selling his house not far from theirs that he bought back in 1971. He’s asking $11 million. He paid $150,000. Isn’t time a wonderful luxury? Which brings me to margin of safety.

Margin of safety was the phrase made popular by Warren Buffett’s mentor and teacher at Columbia University, Benjamin Graham and is the central concept in Graham’s book The Intelligent Investor. It sits on my desk as a constant reminder of who I work for since it was a gift from Dick Young when I first began working with him back in 1998. It’s also worth noting I never remember hearing about the book in business school. Margin of safety must be too boring.

At the core of margin of safety you’ll find common sense and reality. Warren Buffett does a good job of making things make sense. Here’s how he describes margin of safety:

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…

Much of my day is spent helping investors like you understand their margin of safety. I have found it’s often much lower than they themselves believe it to be. And unfortunately too many investors learn the hard way—they only realize their margin of safety threshold when it’s too late.

My takeaway for you today, and you can be sure I’ll write more on this in future posts, is that Warren Buffett’s margin of safety is different than yours or mine, just like it was different from Ben Graham’s. There’s a difference between your truck and Warren Buffett’s. Don’t believe it for a second if you think he’s driving over the Grand Canyon with his life savings in it. But you know who’s buying yours if the bridge doesn’t hold.

 

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E.J. Smith

Editor-in-Chief
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com.