What “Invest With a Margin of Safety” Really Means

0:00We say it every week and probably multiple times during some episodes. Invest with a margin of safety, emphasis on the safety. But what does it actually mean? Where does it even come from? It actually comes from the book, The Intelligent Investor by Benjamin Graham. And it's one of the most famous books, at least for the stock market of all time. And it's one of the key tools that Warren Buffett used throughout his journey and his career. Today, Andrew and I are going to dive into what the catchphrase actually means and how we can apply it to our daily lives. Here we go. The other night I'm online shopping for printer ink.

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3:08My name is Stephen Morris, and he is Andrew Saylor. And today we're going to answer one of my biggest questions when I when I started working with the company, with the podcast is this margin of safety mean and where does it even come from? And so we're going to dive into the intelligent investor. And I think it's fun because Andrew sent me a meme a while ago. I don't remember why you sent it to me, but it was like someone throwing the intelligent investor into a burning trash can. And it's I know that's the joke of like any time things go bad, everybody's just like, ah, screwed. It doesn't apply anymore.

3:52It's 100 years old. But do you remember why you sent me that meme? Something was going on that was crazy. I don't remember what it was. it wasn't all birds but it was to the level of like an all birds kind of event that's right all birds it was all birds that's what it was okay yeah definitely and so if you haven't listened to that episode all birds is a shoe company that has completely rebranded into ai and then and i don't mean like ai helping them make shoes i mean like cloud-based ai company um have Have we got any news on how Allbirds is doing? I haven't looked, but I just remember the stock was up six, seven, eight X or something crazy.

4:39Well, what's the point of trying at this point? Stock markets, cray, cray, bro. Yeah. But anyway, I digress. We're talking about the intelligent investor and Benjamin Graham. So, Andrew, before we actually get into it, because I mean, I know some people don't enjoy reading or maybe they're just getting into the stock market or whatever and never even heard of Benjamin Graham. Who exactly is he and why is he important to us? So he basically was a professor at the Columbia Business School. And he, like you said, became popular because of Warren Buffett. I have one of, I have the book that we're talking about right here.

5:22There's a quote on the top. Warren Buffett says, by far the best book on investing ever written. And I think that one line probably sold at least a million copies of the book. But just to call him an author, I think it's a little bit of understatement. Like I said, he was a professor at Columbia Business School. And so not only did he teach Warren Buffett about a certain way of value investing, So there's this group called the Super Investors of Graham and Dodd, and this is something that was afterward of the Intelligent Investor. Just to give a few, I asked Gemini to kind of summarize this. A few of the investors who were either taught by Benjamin Graham or influenced by Benjamin Graham, you had Walter Schloss earned 21 % a year.

6:15Tweety Brown earned 20 % a year and this is over like either multi decades or decade plus obviously Warren Buffett earned close to 30 % a year Sequoia Fund 18 % a year Charlie Munger 20 % a year Rick Gurin 33 % a year this was over 18 years and then a few others all from the same school of thought that Benjamin Graham started, which is this idea of value investing. And one of the things that Warren Buffett points out in the book, and it might have came from like a speech, but basically it's all these guys applying a similar philosophy, but doing it in completely different ways, completely different stocks, but all centered around the Benjamin Graham idea, margin of safety, and trying to go against what Mr.

7:11Market thinks. yeah and i think that's one of the key things to to really point out is that then not only did they do it in different ways they did it completely different stocks completely different mindsets and i feel like what mr market tried especially on the on the x machine there were they're trying to pump us into believing that you have to own these stocks if you don't own stock one you're an idiot and you're going to miss out on returns and while you know monger didn't didn't have the same portfolio as as buffett he still he still did pretty good for himself so i think that's one of the biggest lessons at least for me that i guess This may be just wrong to say one of the biggest lessons, but that's a huge lesson for me is you don't have to listen to the X machine or social media or whoever started talking CSNBC.

8:20My favorite guy, I can't remember his name off the top of my head. Oh, Jim, Jim Kramer. Anyway, you don't have to listen to him. You can literally do your own research, find your own companies and chances are you're you're going to succeed over time. Fun fact, he is featured in the intelligent investor, believe it or not, because they did a revised version with Jason's week from wall street journal. And he quoted Jim's, Jim Kramer at the, at the top of the peak in 1999. And he might've said, I don't want to misquote, but it was, it was funny. it like kind of confirms some of the way you feel that's like printed for everybody to read that's funny yeah i mean and you know it's no shade like jim kramer's i just find him annoying um that's my biggest takeaway from from all of it is he just bugs me but he's too eccentric i guess is is my he's way too eccentric anyway so now that is funny though i did not realize that so along your journey andrew's journey when when did you actually read the first time the intelligent investor do you remember yeah it was the second book i ever read about the stock market i literally saw buffett's name on there and i was like okay well i know that guy i've heard that guy's name before so i bought his i bought intelligent investor and i bought peter lynch because i was like oh i've heard of merrill lynch and that was my thought process and so luckily i did not start with the intelligent investor i started with peter lynch's book that one was a lot gentler to me um but i read once i read the intelligent investor i was like wow this immediately clicks and that was something that um buffett said too in that letter that's printed in the intelligent investor he's like this kind of philosophy either instantly catches with you or it doesn't and so um i wonder if maybe that's why it's so divisive is people just don't want to i don't know like some people just get really into it like i did and others would prefer just put in the trash can i wonder if that's because well i guess now nowadays we we've kind of lost our ability to have a long-term mindset it's become really unique it seems like and i don't have like statistics or anything to that it's just what it feels like to me is that you know the more i talk to people the more it's like that's 20 years from now i can't think about that it's like yo like it's 20 years from now I was going to be here tomorrow.

11:19So I don't know if that's part of the reason why it just clicks. I definitely think that it depends on what you want, at least for me. It definitely depends on what you want, because we've talked about my experience day trading. That definitely clicks with me, and that scratches a lot of itches for me. but once I got into long-term investing and figured out you know value investing all that stuff it's like man like this is this is where it's at and so I mean I definitely think it can it can scratch multiple itches or you can scratch multiple itches in the market but uh that is really interesting that Warren Warren noticed that as well that that long ago because I'm guess and he probably said that back in you know the 80s yeah i i think that's directionally correct um and it's funny because he said that even though there's been these great track records and it's all public and you can see it people still just don't want to think it will continue the work or just works at all.

12:36So he frames that in a positive light, like that will always be opportunity for the people who are willing to give this whole value investing thing a try because they were calling it outdated even in the 80s. So it's a common thing. Lots of people are putting their intelligent investor books in the garbage very regularly. It's not like a brand new idea. Well, let's be honest, it's not the easiest book in the world to read. This is true. So, I mean, let's go ahead and then just transition and dive right into chapter, what is it, 20? Margin of Safety. And let's translate it, I guess, into simple English.

13:29what that chapter is really trying to drive home, why it's so important, because it's pretty much your entire investing philosophy can just come from that simple phrase. Yeah, there's a few pieces to it. And it's a lot of stuff you and I have said over and over again, especially recently, because we did Back to the Basics. If you haven't listened to that, go back and listen to our most recent Back to the Basics. That was a great primer, but he uses like an engineering analogy. So if you have a bridge and let's say it holds 10 ,000 pounds or whatever the number is, I don't know what it was. You probably don't want to drive a car that's like 9 ,999 pounds.

14:19You want to drive a car that's like 7 ,500 pounds. So you have that big margin. And that's really what Buffett was getting to was, I don't want to just be safe. I want it to be so obvious that I'm safe, that I'm comfortable putting this money into the stock market. That is the way Buffett thinks about it. That's the way Graham taught about it. He took this approach of you're being business minded when it comes to the stock market. you have to behave like a business person. And so that means being honest with what you can know and being honest with what you can't know. But basically, if you can know what that safety level is, you want to undershoot that safety level by a lot because the market's unpredictable, the economy's unpredictable, businesses are unpredictable.

15:20So the only way you can really give yourself that cushion is by buying with a margin of safety, which means you're buying when the price is way under what the actual business is worth. So they use similar numbers. If the business is worth$10 ,000, you want to pay$7 ,500 for that business. You don't want to pay$9 ,999 because if you pay close to what the price is of that business, and things don't go the way you thought, or maybe you were too optimistic, then you probably lose on that deal. But if you buy the business when it's super cheap, then even if you thought it's worth 10 grand and it's really worth nine grand, you're still making a great profit on it because you left that margin of safety in there.

16:13And that's the biggest picture, what the concept behind that is. Right. So you've already covered, I would say, three of the main principles that we just talked about and are like you said, are back to the basics. Stay in your circle of competence. Use diversification. and i i read i don't remember where i read it uh last week but i read it they they defined or described it as using training wheels as or using diversification as your training wheels i think that's one of the most shocking things i learned when i started working for you or this company is that Warren Buffett wasn't really diversified in the end.

17:12At least not by the sense that we put to that definition today. But he also didn't need to be. And I think that that was something that was really hard for me to learn is that different people can play by different rules. and um so i thought that was really a really interesting thought is using it as your training wheels till you get to a place to where diversification is great if you can if not it's not going to break you and then also the you know making sure that you're investing on financial strength in the company, not just the emotion of the company or, you know, whatever the case may be with that, you know, can the company survive a bad year?

18:07And if the answer is no, then obviously you don't want to invest in that company. One of the things that I think is important to me, learning from this mindset is that you can't anchor on yourself on the the not necessarily the price tag of the company and then i learned this lesson when we invested in what was it markel is that stupid expensive i think anyway we were investing in a company crazy expensive and that that price tag really really hung me up and it was you guys like explaining to me that we're investing in the the business not the price tag and that was a huge lesson for me to realize that it's okay for the price tag to be expensive it's okay for it to be cheap just because it's called value investing doesn't mean it's it's cheap um and that was that was just such a hard hard lesson that it's it's business plus risk plus uh the plus price paid like that is a factor but it's not the only factor that we anchor our investment on does that make sense yeah yep so i think that's what that's that's probably one of the biggest lessons i've had to learn or at least adjust in my my way of thinking so how do you apply these rules to to your thesis whenever you're looking at a stock i'm excited to share our friends over at the plink app release a major upgrade featuring a sleek new look real-time insights smoother trades and tools that help you feel more confident with every move.

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22:11I'm trying to get back to that mentality. uh it really depends on like what the market is presenting but i was doing uh i made a spreadsheet the other day it probably doesn't surprise you uh i called it like my film like i was like looking my film room like i'm a high school quarterback and uh i know this for me personally all my best stock picks were done when the price to earnings PE ratio was lower. And I had a few companies where the PE was higher and those did well, like Costco or Visa, but those are kind of like slow and steady gains over time. The stocks have had explosive gains almost uniformly were bought at a low PE ratio.

23:04And so when I think of, okay, how do I want my next years of investments to go? Maybe I lean more back to that again, if the opportunities are there. And how that plays out in the real world is buying the kinds of stocks that people don't get excited about. The ones that, like you said, are not on the X machine, the ones where you can't necessarily point to the chart and say, oh, this is the greatest business of all time. I've bought stocks like that, like Domino's did not do well. Starbucks did not do well. Sure, they had awesome 20 year track records, but that's not a guarantee for the future.

23:50So I try to constantly like not be too dogmatic about it, not be super like, you know, you're either this or you're that, or I'm value or I'm growth. But just trying to take what the market is giving me. But it's an interesting time for us to be recording this because with the way the market has been, it seems like more stocks are on sale. And so we might have more of those opportunities to buy cheap stocks. And when the market kind of gets more excited, it doesn't take much for them. If they get a little bit excited about the stock, it has a low PE, you start to see that stock come up quite a bit.

24:32So, yeah, and then trying to always buy quality businesses, I think, is very important, too. Definitely. To that, I learned in researching for this episode, I learned a new writing technique that I think is really cool. and that is write down what will make your thesis about a company wrong so i'm sorry not wrong but what will make that company fail so if we're talking about you know caterpillar or uh ferrari or some of the you know alphabets some of the companies we've talked about what makes them fail. And if you can't accurately write at least three things that can make that company fail, you're guessing.

25:32Because you don't understand that company well enough. So I thought that was pretty cool. I haven't put that into practice yet. It was a technique that I just read about. and so I'm excited to use it but you know me I'm a nerd I love to write things down so we'll I'll let y 'all know here probably six months if it works out well or not yeah I like it I guess my next question Andrew is what what do you tell someone so you know if you're teaching your daughter about the stock market and what you do in the stock market how would you explain to her the difference between volatility and risk. Assume to my daughter, assuming she doesn't fall asleep within 30 seconds of me opening my mouth.

26:27Well, she's not going to be a teenager forever.

26:33Yeah. I mean, uh, so stock market goes up and down. Um, that's volatility risk is like you're saying you want to write down the reason a business would fail. Real risk in the stock market is not the roller coaster. It's the business losing its advantage over its competitors, the business failing to grow. All of these things are true failure. And those are the losses that will stick. I just really like the roller coaster visualization, because I think that summarizes the stock market well in the short term. But you zoom out and you see a chart that looks more steady up and to the right for the stock market.

27:15And you see that for the businesses that are good businesses. And so you want to find good businesses. And whenever I have conversations with people, I'm never talking about a PE ratio or a valuation or anything, no DCF talk, surprise, surprise. But it always comes down to that quality of the business. and one of the things that was mentioned by Benjamin Graham, which I don't think a lot of people realize because he uses a formula in the intelligent investor and so everybody gets caught up on this formula he used and they say that formula is out of date. But really one of the things he did mention, which is timeless, is he says the value comes from what the company can profit, like what's the term he used?

28:04their profitability power, their earnings power, their future earnings power. And you don't want that to be like a guess. You're just not taking this completely out of left field. But there should be tangible evidence that shows that there's a high likelihood that they're going to have future earnings power. And that's how you determine their value. So it's not just, okay, stock price here, my guess is there. So much of it's baked into how good of a business is this, and that sets that margin of safety bar. Right, right. That's interesting. And then when you're talking about their future potential, obviously we aren't psychics.

28:53We can't tell exactly what that is, but we can look at companies like Coca-Cola. Coca-Cola has stayed profitable for the most part, stayed relevant completely through some really interesting times when you think about it. especially nowadays because at least Americans have leaned really heavy into getting fit, staying fit, staying clean. And so Coca-Cola has still found a way to stay relevant and profitable, even though statistically they're selling less Coke. now there there's uh i think coke is still number one but number two it's not diet coke it's coke zero is that what i think is what it's called the zero sugar gross

29:58i've never had it um if i if i'm going to to splurge and drink soda then i'm i'm going all in and I'm getting all the bad. I'm not, I don't, I don't drink soda or I try not to drink soda a whole lot. But if I do, like I'm not drinking diet. I'm not drinking. Nope. I'm just going all in. But my preferred drink of choice is Mountain Dew. So I can only imagine, I can't imagine Mountain Dew without sugar. Like that would just defeat the purpose. are we talking like two a couple two liters here you're going to grocery store and you got one two liter in each hand and and we're just gonna go ham on this so the so this is controversial so this is steven's hot take okay if mountain dew comes in plastic it sucks it's either fountain or a can yeah i can get behind this i cannot stand a two liter of mountain dew like the first glass is fine after that it just tastes like crap and i won't drink it um so uh yeah it's got to come from a fountain or a can and i don't i can't explain why i don't know scientifically if that even matters or makes sense.

31:27But that is how I roll. So yeah, it's got to be a can. There's nothing better than a cold Mountain Dew out of the can on a hot day. But anyway, I digress. But yeah, so I just I think when we're talking about a company's relevance, are they going to maintain profitable? That's what we got to look at is what have they done to to stay relevant thus far and that's kind of why uh the the newer the company is the riskier at least in the world sandbox we play in the newer the company is the riskier that company is because we don't have that track record of them staying relevant so i think we were uh talked a couple episodes ago about on or yeah a couple on shoes and that is a really really hard company because they they are very new and that if you listen to that episode that was a lot of questions andrew and i were asking about it as we were researching it is are they going to stay relevant in the future and we don't know it's such a key point i want to i want to like sit here and wait in it for a bit because you gotta say it double click okay okay uh well then i want to triple click on this

32:58um if so i'm not a coca-cola expert like i don't own any coca-cola stock regrettably but i've done a little bit of work into the company and a lot of their real advantages in their distribution. Them and Pepsi just have an insane distribution system with so many retail outlets, grocery, gas, restaurants, which is an irreplaceable and hard, maybe impossible to duplicate kind of positioning. And so I love that you brought up the trends in consumer behavior, the way that they're drinking less sugar and being more active and things like that. If it was just about the Coca-Cola brand or how much people like the flavor Coca-Cola, then yeah, maybe they wouldn't have stood this test of time.

33:52But they have other aspects that are structural to that business, like their distribution system that have allowed them to go with the flow and keep that long term. And so I suspect that that's been a big key for them for a very long time and not just in more recent years, but the recent years have really shown just how much that quality is there. And so if we can do the work on that for other businesses and figure out, okay, what is the thing that's going to make them last? And then to your point, having the track record to show, okay, they have, like, it's not just my opinion that, oh, you know, this aspect about them is so structural and so strong, but actually having that evidence and that track record that you can look back on.

34:45One of the things that Benjamin Graham mentions in this chapter that we're covering is he said, there's a difference between speculation and like intelligent investment and And really, we want to be more on the intelligent side. And it all ties into what we're talking about, about evaluating that business quality and looking for that evidence and that being the driver of the future. And not just like our feelings, ideas, or guesses about what the future will bring. The first time I heard about Bitcoin, honestly, I thought it was a scam. I did not realize it was something that would last and I was wrong.

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