"Redefining Margin of Safety" paper

[Liberty]

Interesting read:

 

https://www.nzscapital.com/sitalweek/redefining-margin-of-safety

 

So what do you do if you can’t predict the future, and don’t want your company caught off-guard as you navigate an uncertain, ever-changing economic landscape? We’ve found that nimble, adaptive companies tend to be successful over the long term and offer investors a wider margin of safety. Indeed, we would argue that relying exclusively on valuation for safety, especially given the accelerating pace of disruption in the Information Age, is downright dangerous

 

(btw, when I post these things it doesn't necessarily mean that I agree with everything, or even most things in it. Sometimes yes, but please don't just assume it -- lots of things are worth reading and thought-provoking without being perfect)

[LC]

More from these guys

 

https://static1.squarespace.com/static/5ca38f3216b6405d11e3d4b4/t/5cd77067c830251ea8301574/1557622902586/ComplexityInvesting_9.1.8_Aug19-1.pdf

 

[LC]

Also just my 2 cents - these read like pseudo-marketing materials where you throw a bunch of fancy words out there and hope it convinces someone to invest with you.

 

Not saying that's the case here as I don't know these guys at all, they may have it right on the money for all I know. But when I hear phrases like "time dilation", "velocity of information"...my eyes roll backwards a bit :)

[Spekulatius]

Also just my 2 cents - these read like pseudo-marketing materials where you throw a bunch of fancy words out there and hope it convinces someone to invest with you.

 

Not saying that's the case here as I don't know these guys at all, they may have it right on the money for all I know. But when I hear phrases like "time dilation", "velocity of information"...my eyes roll backwards a bit :)

 

I would call it BS, plain and simple.

[jschembs]

Interesting discussion, but what I struggle with is the whole idea of margin of safety when not applied to its original concept. They try to take a concept that was largely based on tangible assets (what is known and measurable) and try to apply to an unknown future.

[Liberty]

Also just my 2 cents - these read like pseudo-marketing materials where you throw a bunch of fancy words out there and hope it convinces someone to invest with you.

 

Not saying that's the case here as I don't know these guys at all, they may have it right on the money for all I know. But when I hear phrases like "time dilation", "velocity of information"...my eyes roll backwards a bit :)

 

I think it makes a lot of sense, and is along the lines of what I've been thinking for a long time about the high value of certain attributes of businesses that aren't easily quantified.

 

You may dislike the writing style, but the fact that the adaptability/resilience of a business/management team is worth something is definitely true. Something being hard to quantify doesn't mean it should be ignored (nobody said investing was supposed to be easy).

[jschembs]

Interesting discussion, but what I struggle with is the whole idea of margin of safety when not applied to its original concept. They try to take a concept that was largely based on tangible assets (what is known and measurable) and try to apply to an unknown future.

 

There are two extensions not related to Graham-esque Margin of Safety IMO

 

1) Highly predictable FCF businesses - higher margin of safety

2) Businesses with capital allocators able and willing to invest to reinvent / rebuild for future value - higher margin of safety

 

Both present very interesting opportunities, but IMO also a very different way to evaluate businesses.

[RuleNumberOne]

This would help me understand people's perspectives: when did people on this thread start investing actively?

 

Spekulatius started sometime in the 1980s if i remember correctly.

 

I started in 2006. How about the rest?

[vinod1]

Liberty - Thanks for the links! Appreciate all the links you post, many of which I would have missed if not for you. My comments below are directed at the authors.

 

Since at least 2 decades Buffett, et all are talking about MOS and how it comes in different shapes and forms, not just low price. What is See's purchase?

 

This is a bunch of jargon laden BS. Author tries too hard to sound sophisticated, "ergodic" - come on, it straight from Taleb :) Ants and applicability to finance - Mauboussin mentioned that in 2005 and I was really impressed at that time, now not so much.

 

Vinod

[scorpioncapital]

He has a point that it is extremely hard to maintain a moat for a long time. Good analysis and selection may extend the shelf life but I read somewhere that of the Dow 30 stocks, very few remain today. It's all been merged into other companies or replaced.  I know Buffett says to make a good decision and you don't have to monitor your stocks so often but this is very difficult. Perhaps you can have a good working lifetime of good stocks. I really think owning an index that replaces stocks into it like S&P or Dow is not a bad idea given this fact of life.

[Spekulatius]

He has a point that it is extremely hard to maintain a moat for a long time. Good analysis and selection may extend the shelf life but I read somewhere that of the Dow 30 stocks, very few remain today. It's all been merged into other companies or replaced.  I know Buffett says to make a good decision and you don't have to monitor your stocks so often but this is very difficult. Perhaps you can have a good working lifetime of good stocks. I really think owning an index that replaces stocks into it like S&P or Dow is not a bad idea given this fact of life.

 

Yes, I believe it is correct. Compounders that work over decades are rare and in most cases, they keep compounding because management pivots and makes smart decisions. Look at Disney for example - early on it was founder driven and the moat was drawn animations, then parks and then they fizzled on the 70 and 80’s until they got into regular films, CGI then cable (with Eisner), CGI animations (Pixar) then adding additional IP and now direct to consumer. They have to reinvent themselves every 15 years or so to stay relevant.

 

Newspapers were a great business for a 100 years until the wheels came off. Buffet is pretty good at finding companies with enduring moats, in fact that’s his main goal when investing. Even he gets is occasionally wrong (IBM).

 

None of the above is new and has been written about for at least 10 years in the  value investing mainstream.

[Cigarbutt]

It's interesting that this thread, which is about a redefinition, barely touches on the father of the definition (apart from a brief indirect mention in reply #6).

How you define the margin of safety and its relevance may be epoch-specific. Mr. Graham went through a vertiginous rise during the new era period and became a portfolio manager in 1926. His capital grew, mostly from capital appreciation, and went from 450K to 2,5M in three years. The following three years meant a 70% loss. The fact that he survived with grace is, by itself, an accomplishment but he was wise enough to think about the whole thing and come up with some definitions. A fact that is not well known is that, after the dreadful period, he often acted as an expert witness helping cases to argue that market quotations actually undervalued many businesses. His experience was unique and perhaps not repeatable but the atmosphere of the period helps to understand his tone and his anchor points for definitions. It seems that he was able to grasp concept of resilience, optionality and the nature of growth but he chose to focus on past quantifiable measures, put a high price on downside risk and respected the limitations of evaluating the outcomes of the future which, invariably, are tied to the general level of business conditions.

 

An argument could be made that such a confluence of events won't happen again, that he was unable to recover from the permanent bruising and that we was, in the end and perhaps because of this attitude, an average investor (if one forgets Geico which is an investment that didn't fit his margin of safety definition) but it seems that Mr. Graham was at least right in the need to remain humble and the contrarian side of me wonders if his teachings are not the most relevant when it is felt that he no longer is.

[Jurgis]

Liberty and LC, thanks for posting papers of NZS guys. They were an interesting read.

 

 

 

Although I am not sure if the 50%gain/40%loss coin toss system is really non-ergodic. Maybe I am misunderstanding ergodicity or maybe they are. Or maybe they meant different system than the one they specified. Or maybe I misunderstood their system spec. ;)

[RuleNumberOne]

Ben Graham was an active investor at a time when bullshit accounting was widespread. Before 1934 there was plenty of fraudulent accounting and securities crimes. Graham and Buffett principles are always valid and timeless. They are few and simple - e.g. the sun rises in the east and sets in the west and that is not going to change.

 

Can't blame NZS or others to try to make a living by trying to get attention. That is the only way for them to put food on their tables.

 

But more relevant for us - I think bullshit accounting is very widespread right now. Revenues need barely advance, but "non-GAAP profits" can be made to grow in a variety of ways:

- shift from cash compensation to stock compensation

- capitalized R&D expenses through acquisition followed by non-GAAP writeoffs

 

Even GAAP results can be faked by the standard practice of granting pre-IPO stock at an artificially low price and reporting artificially low GAAP expenses for several years post-IPO.

 

If investors don't want to get obliterated, they have to ride momentum stocks thriving on bullshit accounting. It becomes self-fulfilling and can go on for years.

 

P/Es and P/S ratios have been increasing rapidly without sales growth. If the Fed tries to arrest this, Trump tweets and threatens Powell furiously every hour, the IMF head (aka the European Mutual Fund) starts issuing dire warnings, financial journalists scream at the Fed. Meanwhile Italy's GDP growth gets reported as 0.1 -0.1, -0.1, 0.1, 0.1, 0.1, 0.1 over the last 7 quarters. Italy with the largest stock of sovereign debt in Europe can wipe out the European banking system. Lots of bullshit going on right now everywhere.

 

Very dangerous times. As Buffett says, speculation is most dangerous when it looks easiest.

 

It's interesting that this thread, which is about a redefinition, barely touches on the father of the definition (apart from a brief indirect mention in reply #6).

How you define the margin of safety and its relevance may be epoch-specific. Mr. Graham went through a vertiginous rise during the new era period and became a portfolio manager in 1926. His capital grew, mostly from capital appreciation, and went from 450K to 2,5M in three years. The following three years meant a 70% loss. The fact that he survived with grace is, by itself, an accomplishment but he was wise enough to think about the whole thing and come up with some definitions. A fact that is not well known is that, after the dreadful period, he often acted as an expert witness helping cases to argue that market quotations actually undervalued many businesses. His experience was unique and perhaps not repeatable but the atmosphere of the period helps to understand his tone and his anchor points for definitions. It seems that he was able to grasp concept of resilience, optionality and the nature of growth but he chose to focus on past quantifiable measures, put a high price on downside risk and respected the limitations of evaluating the outcomes of the future which, invariably, are tied to the general level of business conditions.

 

An argument could be made that such a confluence of events won't happen again, that he was unable to recover from the permanent bruising and that we was, in the end and perhaps because of this attitude, an average investor (if one forgets Geico which is an investment that didn't fit his margin of safety definition) but it seems that Mr. Graham was at least right in the need to remain humble and the contrarian side of me wonders if his teachings are not the most relevant when it is felt that he no longer is.

[Liberty]

Liberty - Thanks for the links! Appreciate all the links you post, many of which I would have missed if not for you. My comments below are directed at the authors.

 

Since at least 2 decades Buffett, et all are talking about MOS and how it comes in different shapes and forms, not just low price. What is See's purchase?

 

This is a bunch of jargon laden BS. Author tries too hard to sound sophisticated, "ergodic" - come on, it straight from Taleb :) Ants and applicability to finance - Mauboussin mentioned that in 2005 and I was really impressed at that time, now not so much.

 

Vinod

 

I'm not saying it's a new idea that he invented from scratch. Of course it's basically a restatement of "management quality matters a lot" and he explains some of the reasons why.

 

In investing, all the important ideas are basic. We just forget them constantly, so we have to revisit them over and over again and hope for incremental insights and better memory scaffolds so they are easier to recall and apply when needed and such. That's my method anyway, good for you if you can look at something once and never relearn it and apply it perfectly going forward.

[RuleNumberOne]

Of course I support Trump in goosing the market. He needs to do whatever it takes to keep the liars and thieves (Elizabeth, Bernie, AOC) away from the White House.

 

Ben Graham was an active investor at a time when bullshit accounting was widespread. Before 1934 there was plenty of fraudulent accounting and securities crimes. Graham and Buffett principles are always valid and timeless. They are few and simple - e.g. the sun rises in the east and sets in the west and that is not going to change.

 

Can't blame NZS or others to try to make a living by trying to get attention. That is the only way for them to put food on their tables.

 

But more relevant for us - I think bullshit accounting is very widespread right now. Revenues need barely advance, but "non-GAAP profits" can be made to grow in a variety of ways:

- shift from cash compensation to stock compensation

- capitalized R&D expenses through acquisition followed by non-GAAP writeoffs

 

Even GAAP results can be faked by the standard practice of granting pre-IPO stock at an artificially low price and reporting artificially low GAAP expenses for several years post-IPO.

 

If investors don't want to get obliterated, they have to ride momentum stocks thriving on bullshit accounting. It becomes self-fulfilling and can go on for years.

 

P/Es and P/S ratios have been increasing rapidly without sales growth. If the Fed tries to arrest this, Trump tweets and threatens Powell furiously every hour, the IMF head (aka the European Mutual Fund) starts issuing dire warnings, financial journalists scream at the Fed. Meanwhile Italy's GDP growth gets reported as 0.1 -0.1, -0.1, 0.1, 0.1, 0.1, 0.1 over the last 7 quarters. Italy with the largest stock of sovereign debt in Europe can wipe out the European banking system. Lots of bullshit going on right now everywhere.

 

Very dangerous times. As Buffett says, speculation is most dangerous when it looks easiest.

 

It's interesting that this thread, which is about a redefinition, barely touches on the father of the definition (apart from a brief indirect mention in reply #6).

How you define the margin of safety and its relevance may be epoch-specific. Mr. Graham went through a vertiginous rise during the new era period and became a portfolio manager in 1926. His capital grew, mostly from capital appreciation, and went from 450K to 2,5M in three years. The following three years meant a 70% loss. The fact that he survived with grace is, by itself, an accomplishment but he was wise enough to think about the whole thing and come up with some definitions. A fact that is not well known is that, after the dreadful period, he often acted as an expert witness helping cases to argue that market quotations actually undervalued many businesses. His experience was unique and perhaps not repeatable but the atmosphere of the period helps to understand his tone and his anchor points for definitions. It seems that he was able to grasp concept of resilience, optionality and the nature of growth but he chose to focus on past quantifiable measures, put a high price on downside risk and respected the limitations of evaluating the outcomes of the future which, invariably, are tied to the general level of business conditions.

 

An argument could be made that such a confluence of events won't happen again, that he was unable to recover from the permanent bruising and that we was, in the end and perhaps because of this attitude, an average investor (if one forgets Geico which is an investment that didn't fit his margin of safety definition) but it seems that Mr. Graham was at least right in the need to remain humble and the contrarian side of me wonders if his teachings are not the most relevant when it is felt that he no longer is.

[Cigarbutt]

Of course I support Trump in goosing the market. He needs to do whatever it takes to keep the liars and thieves (Elizabeth, Bernie, AOC) away from the White House.

...

Of course I support Trump in goosing the market. He needs to do whatever it takes to keep the liars and thieves (Elizabeth, Bernie, AOC) away from the White House.

2 questions:

1-Are you a central banker or something? :)

2-Can you elaborate on the link between your comment and the underlying theme of the thread or did you just want to vent a political opinion?

[vinod1]

Liberty - Thanks for the links! Appreciate all the links you post, many of which I would have missed if not for you. My comments below are directed at the authors.

 

Since at least 2 decades Buffett, et all are talking about MOS and how it comes in different shapes and forms, not just low price. What is See's purchase?

 

This is a bunch of jargon laden BS. Author tries too hard to sound sophisticated, "ergodic" - come on, it straight from Taleb :) Ants and applicability to finance - Mauboussin mentioned that in 2005 and I was really impressed at that time, now not so much.

 

Vinod

 

I'm not saying it's a new idea that he invented from scratch. Of course it's basically a restatement of "management quality matters a lot" and he explains some of the reasons why.

 

In investing, all the important ideas are basic. We just forget them constantly, so we have to revisit them over and over again and hope for incremental insights and better memory scaffolds so they are easier to recall and apply when needed and such. That's my method anyway, good for you if you can look at something once and never relearn it and apply it perfectly going forward.

 

The issue I am pointing to is that the message is needlessly complex and jargon laden to convey simple points.

 

I try to capture all the investment wisdom I come across and document them, precisely because I want to review them periodically. I even have a recurring task on my calendar every quarter to read them. Please see attached screenshot.

 

So when I tried to read these articles to capture the main points, I found it needlessly complicated and I gave up. Hence my irritation. Perhaps I should not have posted my comments, if I have nothing nice to say.

 

Again, I really appreciate all the links you post and I do find them very helpful.

 

Vinod

 

[Liberty]

Got this from the author of the paper, who wanted to post here but didn't have an account, so I'm posting it for him:

 

 

If you want to get in touch, he's at: