Friday, April 2, 2010

The Intelligent Investor (Part 5): Margin of Safety and Conclusion

As noted in the previous post, the Intelligent Investors have these traits:

- They see stocks as businesses - when you buy a stock you become an owner of that company
- They recognize two basic patterns the market has in unsustainable optimism and unjustified pessimism - both extremes are wrong so maintain a level head during bubbles and crashes
- They understand future value is a function of present price - the higher price you pay, the lower the return you will be
- They maximize margin of safety - never overpaying for a stock and reducing risks
- They develop discipline and courage - recognizing that your biggest enemy is yourself and not to be swayed by the market or other people's moods. You decide your fate.

Margin of safety is never overpaying for a stock. When you buy a bargain stock, you have a level of safety built in. This is similar to buying real estate. By buying something below assessed price, you have equity already built in. This gives you a margin of safety.

Margin of safety also recognizes the need to diversify investments. Graham says to have 10-30 good stocks that you follow at a minimum.

Margin of safety also recognizes you are investing and not speculating. Speculating is betting a company will up or down on a certain day, week, month. Gambling is a form of speculating whereas investing is buying a business that is on sale at a bargain or discount based on definite reasoning and statistical data.

Graham concludes his book with the following principles for the Intelligent Investor who treats his investments like a business:

1. Know what you are doing, know your business

2. Do not let anyone else run your business unless you can supervise his performance with adequate care and comprehension or you have unusually strong reasons for placing implicit confidence in his integrity and ability

3. Do not enter upon an operation that is, manufacturing or trading in an item unless a reliable calculation shows that it has a fair chance to yield a reasonable profit. In particular, keep away from ventures in which you have little to gain and much to lose.

4. Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it-- even though others may hesitate or differ.

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