Margin of error

Challenged to distil the secret of investing into just three words, Benjamin Graham offered the phrase MARGIN OF SAFETY. The adjectives ‘value’ and ‘growth’ are routinely butchered, manipulated, stretched and abused by fund managers, but the defining difference between the two is that ‘value’ stocks possess a margin of safety, and ‘growth’ stocks invariably don’t. When a genuine ‘value’ stock – listed shares of a high quality company with disciplined, shareholder-friendly management and generating high and sustainable levels of cash – gets cheaper, the logical response is to buy more. When a ‘growth’ stocks gets cheaper, it may simply mean that the tide is going out. Dollar cost averaging into ‘value’ stocks makes sense for those with the liquidity to do it. Dollar cost averaging into ‘growth’ stocks can be straightforwardly dangerous. Example: Alliance Capital and its fund manager Alfred Harrison, acting on behalf of the Florida state pension fund, elected to dollar cost average shares of Enron stock as they fell during the second half of 2001. The Florida state pension fund ended up losing $328 million.

Margin of error