Saturday, 21 January 2012

Margin of Safety Concept in Speculation and Investment

A Criterion of Investment versus Speculation

Since there is no single definition of investment in general acceptance, authorities have the right to define it pretty much as they please.

  • Many of them deny that there is any useful or dependable difference between the concepts of investment and of speculation. 
  • We think this skepticism is unnecessary and harmful. 
  • It is injurious because it lends encouragement to the innate leaning of many people toward the excitement and hazards of stock-market speculation. 
  • We suggest that the margin-of-safety concept may be used to advantage as the touchstone to distinguish an investment operation from a speculative one.

Probably most speculators believe they have the odds in their favor when they take their chances, and therefore they may lay claim to a safety margin in their proceedings.
  • Each one has the feeling that the time is propitious for his purchase, or that his skill is superior to the crowd’s, or that his adviser or system is trustworthy. 
  • But such claims are unconvincing. 
  • They rest on subjective judgment, unsupported by any body of favorable evidence or any conclusive line of reasoning. 
  • We greatly doubt whether the man who stakes money on his view that the market is heading up or down can ever be said to be protected by a margin of safety in any useful sense of the phrase.

By contrast, the investor’s concept of the margin of safety—as developed earlier in this chapter—rests upon simple and definite arithmetical reasoning from statistical data.
  • We believe, also, that it is well supported by practical investment experience. 
  • There is no guarantee that this fundamental quantitative approach will continue to show favorable results under the unknown conditions of the future. 
  • But, equally, there is no valid reason for pessimism on this score.

Thus, in sum, we say that to have a true investment there must be present a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.

Ref:  The Intelligent Investor by Benjamin Graham

CHAPTER 20  “Margin of Safety” as the Central Concept of Investment

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