Sunday, July 29, 2007

The Three Most UnderValued Words in Investing: MARGIN OF SAFETY

Margin of Safety.

These words were officially brought to light in The Intelligent Investor by Ben Graham. And when you mention them to most money managers, they nod in approval and understanding. Yet, statistical performance results tell you another story. When 8 out of 10 mutual funds fail to be the benchmark, it means fund managers are simply over paying for businesses.

Only three types of investments exist -

1. under priced,
2. fairly priced, and
3. overpriced.

Value investors, by nature, engage in only three activities:

1. Buy the under priced assets
2. Hold or sell the fairly priced assets.
3. Avoid the over priced assets.

Yet finding under priced assets is not easy nor should it be. Further, an asset's intrinsic value is not an exact number but instead a value determined by several analytical inputs based on data and reasoning. Having a satisfactory margin of safety protects the intelligent investor from engaging in folly that results in a permanent loss of capital.

Ben Graham succinctly put it when he said,

"An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

Whether or not money managers realize it, most "investments" are more often just mere speculative activities hinging upon the actions of management and the future results of the business. Of course in a bull market, speculation is mistaken for investing. Bull markets tend to disguise everyone as an investing genius. But we all know that a value investor is more focused on making it through bear market storms relatively unscathed.

Buffett said it best in his letter to his limited partners in 1961:

"I would consider a year in which we decline 15% and the [Dow Jones] average 30% to be much superior to a year when both we and the average advanced 20%."

Most investors don't fully grasp this investing approach, and the result is inferior long-term performance relative to the benchmarks. Value investors always demand a margin of safety. And a margin of safety can come in various forms, but its sole purpose is to diminish the probability of a permanent loss of capital. Most important, the margin of safety insulates the enterprising investor from the inevitable surprises that Mr. Market may have up his sleeve.

Finally, remember that the intrinsic value of a business changes over time, and therefore, so will the margin of safety. A 50% margin of safety one year may erode or widen the following year. If your assessment of intrinsic value changes, then so must your investment decision - to either buy more of a now more under priced assets with a greater margin of safety, or dispose of a 50 cent dollar that has now become a 90 cent dollar. Either way, all roads lead to one path in which you come out with minimal loss of capital.

Price is what you pay, value is what you get.

For more on margin of safety, check out my write up on at the Motley Fool:

Tuesday, July 24, 2007

Some Valuable Comments

I recently received the following comments from two readers:

1. "A few ideas, to be taken with a grain (or many grains) of salt: while it's good to talk about the articles you've written, I think most people don't like getting a detailed rundown of all of them. Perhaps writing a blog post that further expands on an article is better, that way you indirectly (thus subtle) point us blog readers in their direction...Also, perhaps posting more often? Sometimes you have really good, inspired posts. It'll probably be a challenge for you to post everyday, but even being consistent with posts every other day would help. Hey just some constructive ideas..."

These are indeed some very constructive ideas. I am sure that it would have been more informative to expand on the articles that are being written for the Fool, so I will keep this in mind. My ultimate goal was to really provide an "archive" link if you will, of my various other writings. I want this blog to be a central source for any other thoughts and ideas that I may cover outside of the blog.

The lack of consistency in the postings is something I have been aware of and I am glad someone mentioned it (hence why I took the easy way out and just gave you links to other articles). Beginning next month, my priority will naturally shift to running the Gad Partners Fund via Gad Capital Management. The blog will remain active, but it will certainly have to take a back seat. Nonetheless I will provide some new content as best I can.

I had one comment asking whether or not I would post the partnership letters on the blog. Unfortunately, because of the "hedge fund" like similarities of the partnership with respect to its legal formation, I can not advertise the partnership like a mutual fund. While posting the letters might not be considered "advertising," I feel better playing in the center of the court rather than around the edges.

2. "Congrats on getting GCM off the ground. Do you still plan on writing for and the blog once you’ve started GCM? Thanks for the blog it has helped lead me in the right direction for my investing education."

I don't deserve this compliment. There are plenty of wonderful value investors out there that have allowed me to make this blog a possibility. I am glad I can be of some help.

With regards to my future writing commitments, let me post my response to this comment:

"Yes, I still plan to continue writing for the blog, the Motley Fool, etc. I feel that the written word is very helpful to an investor. Putting my reasoning on paper is a great mental exercise for me. For example, last week I was wanting to understand the fine points of the securitization process.

As I begin to mentally gather ideas, it occurred to me that it would be very helpful to me to write down the process. The end result was an article. I wish I could say that I would contribute on a regular basis, but with the start of the partnership, the rate of postings will be a little slower, at least initially."

Thursday, July 19, 2007

Three Visits with the World's Best Value Investors

When I started this blog last year, my goal was to provide the value investing perpsectives taken from the world's best investors. As we all know, a common theme amongst investors is the willingness to teach. Investing is after all, a continuous education; a game that never ends. It is these two facets of investing that really keep me going - there is always something to learn in order to expand your circle of competence, and the intelligent investor's goal is to use his knowledge to evaluate businesses and come to independent rational decisions on why he should invest. More often than not, the best investments will occur at the point of maximum pessimism, and you have to trust your reasoning when everyone around you is taking you to task.

Over the past year, I have been extremely lucky to have personally met some of the best investors on the planet.

First in January of this year, I met Warren Buffett. After my mother and father, Buffett is without question the greatest influence and inspiration in my life. Without Buffett's teachings and writings, I can guarantee that I would not be the person I am today. Aside from being the greatest investor in the history of mankind, Buffett's leads a life that sets an example for all to follow. When I asked Buffett about what the most important advice he had for me, he quickly remarked, "Do what you love and make sure your kids love you." The two day visit I had with Mr. Buffett is an opportunity I will always be grateful to him for.

Secondly, this past spring, I visited with Mohnish Pabrai. I first met Mohnish last November at the Value Investing Congress in NYC. On the last day of the event, Mohnish sat next to me during breakfast. Since then, I am very proud to call Mohnish a friend. Already, Mohnish's investment record is legendary and he has decades to go. One day the world will be very grateful that Mohnish is doing what he is doing. I am grateful to call him a friend.

Thirdly, I had an opportunity to visit and spend time with Mason Hawkins. Mason Hawkins is quite simply the most underrated money manager in the business. The accomplishments he has achieved operating under the regulatory framework of the mutual fund industry is impossible to accomplish unless you're Mason Hawkins. True to his form, Mason does what he does because he loves it. As far as I'm concerned, any investor in the Longleaf Funds should name their first born child Mason. As a steward of capital, Mason Hawkins sets the standard all should follow.

In less than six months, I had the honor to spend time with three phenomenal human beings and individuals that I look up to not only for thier impeccable investing ability, but also for the example they set each day. All three were gracious with their knowledge about the world and business and most importantly, thier time. Time to give to someone like me and everyone else who's just as passionate about investing.

Some of you may be wondering why the postings on this blog have been more and more infrequent. Gad Capital Management will begin operations in about a month. GCM will be running the Gad Partners Fund, a value-centric investment partnership deeply rooted in the teachings of Graham, Buffett, Hawkins, and Pabrai. Some really terrific individuals and families have decided to join the partnership. I am very lucky to call them partners.

Tuesday, July 3, 2007

Pabrai Wins Bid to Lunch with Warren Buffett

Mohnish Pabrai recently bid $650,100 to have lunch with Warren Buffett. According to Mohnish, his winning bid was a overdue "tuition payment" to the man who has taught so many.

Lest you think that this was a ridiculous sum of money to fork over for lunch with anyone, I would like to invite you to read my following article at the Motley Fool:

By looking at this lunch from several angles, you begin to realize that this lunch bid was a typical Pabrain value play.

This morning, CNBC interviewed Mohnish about his winning bid. (Thanks to Lincoln Minor for graciously sharing valuable information on all things value investing)