Dear colleagues,it has been a while since last time we shared some success stories of Aliko Dangote of Nigeria. Today i have an idea on margin of safety! Among famous quotes of Warren Buffet that you may have come across is " Rule No. One Do Not Lose, Rule No. Two Remember Rule No. 1". I think Warren Buffet is talking of surety of your steps. Ok, we may seem to be Idolizing him but at least he has made it and the quote makes sense!
How can we avoid losing on our investments? We can by understanding the 'margin of safety' concept! And whats this margin of safety concept? Margin of safety concept is like a white hand stick for a blind person. Before stepping forward the stick searches around and confirms to the holder the safety of the next step!As an investor you should not wake up in the morning and say this stock will go up today or soon because I dreamed last night! You must have a solid reason or theory underpinning your decision.
Example: In roulette, a wheel with numbers 00,0 and 1 through 36 has 38 slots. The casino offers a maximum payout of 35 to 1. What if you bet sh.1000 on every number? Since only one slot can be the one into which the ball drops, you would win sh.35,000 on that slot, but lose sh 1000 on each of the other 37 slots, for the net loss of sh 2000. That sh 2000 difference(or a 5.26% spread on your total sh 38,000 bet) is the casino's "house advantage", ensuring that, on average, roulette players will always lose more than they win.Just as it is in the roulette player's interest to bet as seldom as possible, it is in the casino's interest to keep the roulette wheel spinning. Likewise the intelligent investor should seek to maximize the number of holdings that offer "a better chance for profit than for loss". For most investors, diversification is the simplest and cheapest way to widen your margin of safety!As we may have learned from the roulette example, we don't have to expose our portfolios unnecessarily! Instead of being the the betting guy, choose being the casino owner! Ensure that your chances of winning are highest on every move you make.
Investor Versus Speculator! Investor is the casino owner and the speculator is the betting guy. Once over time the betting guy may win, the chances of winning are 2.63% if he bets on one slot out of 38 slots! I he bets on all slots he wins but he loses 5.26% of his investment, Contrary to the Casino Owner who is sure of 5.26% gain on every wheel spin!
Intrinsic value, privileged information,diversification and knowlege may widen your margin of safety! For example when CRDB bank was trading at Sh.110 per share it was undervalued by 45% at the current market price of sh200 per share.This undervaluation provided sufficient margin of safety to the value investors, besides at sh110 it was 99% of book value which meant buying actual asset of the company and getting goodwill for free! If you read my article titled "DCB a great opportunity to buy" you will understand what it means when i talk about margin of safety.
Security of Capital and fair return on investment are basically the focus of Value investors! To balance this two goals, margin of safety concept plays a central role.
Article By
Emmanuel P. Akyoo,
Managing Director,
Epak Capital Ltd,
P.O.Box 10579, DSM
Cell: 0712 459 035, 0784 146 756
