Don’t let anyone tell you otherwise: investment is not an exact discipline. As such, it makes huge sense to build a ‘margin of safety’ into the way you analyse and pick stocks – a point Ben Graham, the father of value investing, recognised when he argued the price you pay for any investment should be cheap enough to allow for a range of unexpected adverse outcomes.
Graham also maintained “the purpose of the margin of safety is to render the forecast unnecessary” – a sentiment with which we heartily concur, here on The Value Perspective – while yet another way to think about the idea cropped up recently in a conversation with Sam Sithole and Anthony Ball, who in 2016 co-founded South Africa-based value-oriented activist investor Value Capital Partners.
Speaking on the latest episode of The Value Perspective podcast, CEO Sithole and chairman Ball, who both have private equity backgrounds, framed the margin of safety concept in terms of buying investors time. “In private equity, you might know a failed investment from the beginning but, because you are doing your own valuation, it is more likely to become apparent three or four years after you have invested in it,” says Sithole.
“In the listed space, however, the judgement is on a daily basis and, the moment a company produces its results, your portfolio can fall by 20%, 30%, 40%. A big part of what we have learned, then, is that in the listed space investors are quite jittery about stressed balance sheets and potential capital raises. So, when you are looking for a potential investment, you should avoid these companies where you can.”
Big red flag
The main reason for this, Sithole continues, is that businesses in these kinds of situations do not allow activist investors the time to introduce the changes they believe are necessary to turn them around. “You may be trying to change the strategy or sell assets or whatever but, at the same time, you are having to worry about these other issues,” he adds. “Not having enough time is a big red flag that would dwarf everything else.”
It is not in our nature, here on the Value Perspective, to be quite so involved in how the companies we own are run but we are in complete agreement with Sithole and Ball on the significance of time in investing. After all, if we are buying into businesses that, for whatever reason, are unloved – and thus undervalued – by the wider market, we want other investors to have the greatest possible chance to learn to love them again.
How well-placed (or not) different companies are to cope with the unexpected therefore goes straight to the heart of our investment process, here on The Value Perspective – and it is a point we have made in unambiguously titled pieces such as Why you should, frankly, give a dam about company balance sheets and Why balance sheet strength should interest investors more than ever.
In essence, our process is designed to keep risk front-of-mind by meticulously analysing businesses to ensure they are so financially resilient they should have the time to weather any kind of crisis.
Subscribe to our Insights
Visit our preference centre, where you can choose which Schroders Insights you would like to receive.