Robust Investment Strategy
We have researched the history of investment managers since the Great Depression and believe there is only one strategy that has proven to have a reliably high success rate over a reasonable time horizon of 3-5 years. Warren Buffett learned this strategy from Benjamin Graham at Columbia business school. The premise of the strategy is to avoid, at all costs, the risk of permanent loss of capital. This does not mean that volatility can be avoided but controlling volatility should ideally be a separate issue intended to reduce loss of capital risk over shorter time horizons than 3-5 years. We call this strategy Margin of Safety investing.
While analogous to value investing, we believe the term value investing is inappropriate because it is overly simplistic. For instance, Morningstar (and others) defines a stock primarily by looking at the current price on the stock in relation to earnings over the next 12 months. Since the value of a going concern is realized not over 12 months or even over 12 years, but more over 100 years, this definition has little merit. A margin of safety is afforded only to companies that are likely to have the long-term capacity to turn existing resources (including hard assets as well as products and services) into earnings in the future based on very conservative economic growth assumptions A margin of safety stock might be called a growth stock or a value stock based on the Morningstar definition. Moreover, mixing “value” and “growth” stocks in a portfolio frankly misses the point. Companies with a margin of safety are likely to last economic downturns, and by doing so, may gain market share and grow earnings. However, it is generally not their objective to aggressively grow earnings.
The track record of investors following the Margin of Safety investment strategy goes back to the Great Depression. The first Margin of Safety manager for whom there exists a track record is John Maynard Keynes, who ran the Chest Fund in the United Kingdom during the Great Depression. From 1929 to 1930, the Chest fund lost 50%, while the UK stock market was down only about 40%. However, by the end of 1933 it had recovered its entire loss while the market remained down over 30% – in fact the market remained down through the end of World War II.
Visit John Maynard Keynes website for more information [ link]
The best known Margin of Safety manager is Warren Buffet of Berkshire Hathaway. In 1984, after earning clients an appreciation in book value of 29% p.a., Warren was invited to give a speech at Columbia Business School. At this time many academians had been arguing that the stock market was efficient and that it was foolish to try to beat the performance of the stock market (S&P 500). In answer, Warren presented a group of investors, who “year in and year out” had beaten the S&P 500. The group of investors he presented all had an intellectual patriarch, Ben Graham, from whom they learned the Margin of Safety investment strategy.