MARGIN OF SAFETY SUMMARY

Risk Averse Value Investing Strategies for the Thoughtful Investor

THE MARKET
• The two main options for investors are an Efficient Market Hypothesis (EMH) or an
Inefficient Market Hypothesis (IMH).
• Efficient Market Hypothesis: Financial markets are efficient and prices reflect all
news and information. Thus, it is impossible to “beat” the market.
• Inefficient Market Hypothesis: Securities may be inefficiently priced creating
possibilities for gains above the risk taken, “beating” the market.
• Benjamin Graham described the market as a person that is irrational and overvalues and
undervalues securities
THE MARKET PLAYERS
• Brokers and investors often have conflicts of interests when dealing with customers,
encouraging short-term trading
• Money managers incentives from fees can motivate them to achieve mediocre results.
Thus, they may abstain from securities that have potential for gains.
• The inclusion or exclusion of a security by money managers does not mean it is
valuable or invaluable necessarily, as with Junk Bonds
• The investor must understand the motivations and incentives of the players in the market
• Investors believe they over the long run, security prices tend to reflect the fundamental
value of the underlying business
• Speculators invest in securities on what they predict the behaviors of others to be rather
than on the underlying business
VALUE INVESTING
• Value Investing: buying securities at a discount from their current underlying value and
holding them until their value is realized
• Risk-averse approach which relies on a “margin of safety”
• Value investing is based off the idea of the IMH and that the EMH is wrong.
• With IMH, there is a opportunity to take advantage of mispriced securities
• As a risk adverse approach, risk is as important as return and the relationship between
the two is essential, the margin of safety
• Risk is not based on past stock prices (beta), as pat prices do not necessarily predict
future performance
OPPORTUNITIES FOR INVESTMENT
• The measurement of value is essential to value investing. The author gives 3 business
valuation methods he finds useful
• Net Present value
• Liquidation value
• Stock market value
• Finding good investment opportunities can be done by thinking on the contrary. With the
knowledge of the motivations of the players in the market, the value investor can look for
valuable securities that the market is not interested in
OPPORTUNITIES CONTINUED
• Areas of opportunity
• Catalysts
• Market inefficiencies
• Institutional constraints
• Thrifts: mutual to stock ownership
• Financially distressed and bankrupt securities
• Often sell far below par value because most do not want to invest in them. The
reorganization of these securities may help further to realize value
FUNDAMENTALS OF INVESTING
• Diversification
• Owning different types of securities to lower risk
• Investors should balance between illiquid and liquid assets depending on how well
the market is compensating to bear these assets
• Hedging
• Hedging is valuable in limiting market risk, but can often be expensive and time
consuming
• Investors should have a investment philosophy that conforms to their aims so they can
properly manage and trade securities
INDIVIDUAL INVESTING
• Various opportunities for an individual with limited time include mutual funds,
discretionary stockbrokers, or money managers
• In light of the concepts found in this book, the individual can assess the motivations of
these various opportunities.
• The author encourages an approach to investment that focuses on value investing as the
superior method as other forms of investing have failed.