Money and risk
Benjamin Graham
Margin of safety
Benjamin Graham (United States · 1894–1976) — Margin of safety.
What actually happened?
Before the crash his accounts had made money every year and he was a Wall Street prodigy. Between 1929 and 1932 his fund lost seventy per cent and came close to the end; the household got through on his wife going back to work and help from his mother-in-law. The disaster is what produced the system. If a good judgement can still be wrong, the protection cannot be better judgement. It has to be built into the purchase price. Security Analysis appeared in 1934, and his fund did not have a losing year afterwards.
Mr. Market
Imagine a partner who names a price every day and will buy from you or sell to you at it. He is elated one week and despairing the next. You may deal with him or ignore him entirely; he is not offended and he returns tomorrow. The market exists to serve you, not to instruct you.
March 2020 and the long slide of 2022 were both his depressive episodes. Whoever read the screen as a quotation rather than a verdict was buying.
Margin of safety
Three words for the whole of sound investment. Pay fifty cents for a dollar and a thirty per cent error still leaves you whole. The margin does not raise the return on a correct call; it makes an incorrect one survivable. Every blow-up is a zero-margin position.
A bridge rated for thirty thousand tonnes is posted for ten. Graham took engineering redundancy and moved it into finance.
Where investment stops and speculation starts
An investment operation, on thorough analysis, promises safety of principal and an adequate return; anything failing those tests is speculation. Note that the standard is adequate rather than maximal, and that the line is drawn in the operator rather than in the security.
Two people can hold the same share on the same day, one investing and one speculating. The difference is the analysis standing behind it.
The weighing machine
In the short run the market is a voting machine; in the long run it is a weighing machine. Votes are cast by mood, weight is set by earning power. The investor has two jobs: work out the weight, and wait for the weighing. Not reading the votes is survivable; not knowing the weight is not.
Sell to the optimists, buy from the pessimists. The return comes from other people's mispriced feeling, not from a better forecast.
How do I use it today?
Before any commitment, a share or a job or a company, run his three questions: have I analysed this thoroughly, is the principal or the fallback safe in the worst case, and is the return I want adequate or greedy? Then add one rule: act when the market is in an extreme mood, and ignore the quotes the rest of the time.
Deep read
Read alongside
Further
Lines to keep
In the short run a voting machine, in the long run a weighing machine.
The investor's chief problem, and even his worst enemy, is likely to be himself.