Our approach to common stock investment is based on the margin of safety principle. We live by the adage that success in the stock market is gained by buying at volatile levels and selling out when the public is most optimistic. Therefore, we try to keep our focus on industries where business surprises are unlikely to wreak havoc on owners and are easy to predict. Our principle is not limited to one country, but many. We like searching for great opportunities worldwide; markets like North America and Australia can sometimes become extremely overpriced; therefore, it helps to look elsewhere where shares are not overbought. When dealing with safety, we are not limited to price; we don’t mind paying up for “value,” but we like having companies that offer far greater value than its peers. For example, areas such as consumer staple and consumer discretionary are incredibly competitive; therefore, we look to those with better e-commerce success, automate distribution, or automate production lines.
We need to get to know our companies very well before we buy, so we read all of a company’s available fillings over the past six years, we analyse its industry and competitors (of which there shouldn’t be many). We don’t like buying stocks if we don’t believe it will double or triple in our fund over five to ten years, and we also don’t hold more than three stocks at a time. The biggest argument for diversification is protection from risk. By buying a multitude of stocks, it’s true that you’re lowering the risk that any one stock would fall and wipe out a big chunk of your portfolio. But you’re still not protected from overall market risk when the whole market tumbles. According to Buffett, “Diversification is a protection against ignorance,” and it goes to show that very few fund managers are willing to concentrate their investments in a small number of businesses that they know thoroughly and believe will grow their clients net worth at an attractive rate over the long term.
The concepts we follow with our margin of safety principle is to make sure we never pay more than ten times earnings, we like getting value, and although its little benefit to us knowing this multiple, it’s a good starting point. We look at earnings over five years, so as not to be misled by a recent year of abnormal performance. P/E multiples can change drastically based on uncontrollable factors such as interest rates, sentiment, or government action such as those seen recently; we prefer free cash flow and price to value metrics instead. We cannot forget the importance of honest top management and their integrity in managing their enterprise. Prior to any investment, we like to size up the leadership to determine the alignment of values and fit in line with our investment criteria.
The margin of safety idea becomes evident to us through a difference between the price and the appraised value. It is there, for absorbing the effect of miscalculation or worse-than-average luck. Our margin of safety is demonstrated by figures, persuasive reasoning, and experience. It’s important to know what constitutes “low or high” valuations, simply buying ‘because’ it’s cheap is never wise. We like ‘paying for the present and receiving the future for nothing’, as the future value holds many unknowns and can lead to high speculations with adverse effects.