- The purchasers view the current good earnings as equivalent to “earning power*” and assume that prosperity is synonymous with safety.
- It is in those years that bonds and preferred stocks of inferior grade can be sold to the public at a price around par, because they carry a little higher income return or a deceptively attractive conversion privilege.
- It is then, also, that common stocks of obscure companies can be floated at prices far above the tangible investment, on the strength of two or three years of excellent growth.
- These securities do not offer an adequate margin of safety in any admissible sense of the term.
- Coverage of interest charges and preferred dividends must be tested over a number of years, including preferably a period of subnormal business such as in 1970–71.
- The same is ordinarily true of common-stock earnings if they are to qualify as indicators of earning power.
- Thus it follows that most of the fair-weather investments, acquired at fair-weather prices, are destined to suffer disturbing price declines when the horizon clouds over—and often sooner than that.
- Nor can the investor count with confidence on an eventual recovery—although this does come about in some proportion of the cases—for he has never had a real safety margin to tide him through adversity.
Ref: The Intelligent Investor by Benjamin Graham
CHAPTER 20 “Margin of Safety” as the Central Concept of Investment