In his book – The Dhandho Investor, Mohnish Pabrai discusses why Ben Graham’s emphasis on a margin of safety is vital, aiming to minimize risk while maximizing returns, a strategy epitomized by Warren Buffett’s success.
Assets usually trade at or above intrinsic value, but during extreme distress, like 9/11 or company scandals, they can fall below this value. Although predicting distressed assets is challenging, focusing on a diverse stock portfolio can uncover opportunities as individual businesses or entire sectors occasionally collapse.
Historical figures like Graham, Buffett, and others have consistently sought low-risk, high-return investments, demonstrating that this strategy is key to financial success.
Here’s an excerpt from the book:
Graham’s fixation on margin of safety is understandable. Minimizing downside risk while maximizing the upside is a powerful concept. It is the reason Mr. Buffett has a net worth of over $40 billion.
He got there by taking minimal risk while always maximizing returns. Most of the time, assets trade hands at or above their intrinsic value. The key, however, is to wait patiently for that super-fast pitch down the center.
It is during times of extreme distress and pessimism that rationality goes out the window and prices of certain assets go well below their underlying intrinsic value.
Extreme distress can be caused by macro-events like 9/11 or the Cuban missile crisis. Or they can be company-specific—for example, Tyco’s stock price collapse during the Dennis Kozlowski corruption scandal.
We cannot predict which asset classes are likely to get distressed next. However, if we only focus on a single asset class of stocks, that encompasses thousands of businesses.
Virtually every week, specific businesses that trade on public markets see their prices collapse. At other times, it might be an entire sector that gets written off. More rarely, the entire market sells off due to a macro-shock like 9/11.
Papa Patel, Manilal, Branson, Graham, Munger, and Buffett have always fixated on a large margin of safety and gone to great lengths to seek out low-risk, high-return bets. It is truly fortune’s formula.
You can find a copy of the book here:
The Dhandho Investor – Mohnish Pabrai
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