Margin of Safety. First and always

In the Intelligent Investor Ben Graham defines the central concept of investing as Margin of Safety. It is far more important to consider the question of what can I lose than worrying about how much you can make when buying a stocks. That is of course the direct and exact opposite of how most people approach the stock market. Investors tend to look at a stock and ask how high can this go and send little to no time on what happens if I am wrong. The average investors wants to figure out how many points higher Tesla (TSLA) or Apple (AAPL) can climb in a short period of time and never asks their self what the business is worth and what can go wrong with this sexy exciting stock story that might cause them to lose money. The margin of safety in investing comes from the gap between what you pay and what the business is actually worth. Graham originally defined the margin of safety as a stock that was selling under depressed conditions and was worth less than the amount of bonds that could be safely issued by the company. He also compared the earnings yield on a stock to the prevailing interest rates to find a margin of safety. He further added to that when buying bargain issues the margin of safety comes from the difference between the asset or appraised value of the company and the price paid for the shares. In his classic book entitled aptly enough Margin of Safety legendary investor Seth Klarman echoes Graham by suggesting that investors would do well to focus on tangible assets. In the book he opines “How can investors be certain of achieving a margin of safety? By always buying at a significant discount to underlying business value and giving preference to tangible assets over intangibles.” Like Walter Schloss her prefers companies where management and investors are on the same side of the table advising us to “Give preference to companies having good managements with a personal financial stake in the business.” Graham and Klarman both reference the need to let the market work for you rather than against up. The time to be buying a wide variety of stocks is when the market id s down substantially and there are plenty of bargains around. Graham suggests that investors make the worst choice when buying lower quality companies with poorly defined earnings power under good market conditions. A rising market hides a lot of flaws and if investors are concentrating just of the prove movement of the stock rather than price in relation to the value of the company they are often setting themselves up for losses that may not be recovered. While it is impossible to eliminate market risk you can erase much of the concern about short term fluctuations by making margin of safety the principle focus of you investment activities. It is very easy to get caught up in the stock market story of the day. The stock market is a place where our emotions and even our hard wired psychology can work against us. Buying stocks that are unpopular or even pretty much unknown but are cheap and offer an adequate margin is not going to make for a great discussion at the office or the backyard BBQ. Most individual investors want to talk about the hot stocks of the day like Facebook (FB) or Google (GOOG). Talking about a Liquefied Petroleum Products tanker firm selling at half of book value like Stealth Gas is not going to make you a popular conversationalist. Telling your friends and associates that you are buying that you have been buying a bunch of little banks no one has ever heard of like ESSA Bancorp (ESSA) or HopFed Bancorp.(HFBC)will most likely attract more blank stares than engaging conversation. The key to long term success in the stock market is to win by not losing. By focusing on the price we pay for shares relative to the earnings and asset value of the firm instead of the exciting story or recent price action we create a margin of safety and allow the stock market to work for us instead of against us.