Buffett Owes His US$67 Billion Net Worth to These Three Words - The 5 Minute WrapUp by Equitymaster
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Buffett Owes His US$67 Billion Net Worth to These Three Words

Sep 22, 2016
In this issue
» IPO fundraising crosses Rs 200 bn in 2016
» Gold on the cusp of a big bull market
» ...and more!
00:00
Rahul Shah, Co-Head of Research

I've always found that the best investing lessons are found away from the stock market. In real life.

Here's one of them:

Imagine you're travelling by plane from India to New York. Now, if you were in charge of filling the aircraft with fuel before takeoff, how much would you put in? Would you fill exactly the amount the plane needs to land to New York? Or to be safe, would you throw in, say, 50% more?

Your answer would be the latter, I'm sure. You would correctly reckon that a hundred unexpected things could come up along the way that might extend the flight beyond the scheduled distance or time. And you wouldn't want to take any chances with you and your family onboard, would you?

Ace investor Warren Buffett has been flying planes for more than 60 years. Only, on the side of his plane it says 'Berkshire Hathaway' and his most important passenger goes by the name of 'capital'. For each and every journey the plane has made, Mr Buffett has ensured the safety of his capital as if his life depended on it. While filling the plane's fuel tanks, he chants three magic words over and over again: 'margin of safety, margin of safety, margin of safety...'

Buffett thinks deeply about each and every investment decision he makes. And the safety of his capital is always at the forefront of his mind. It's as if his life depends on it. Buffett admits that he owes a large part of his current US$67 billion or so of net worth to this attitude.

Margin of safety has two parts that work together to give it its power:

  1. You value the business the best you can based on what its future will look like. However, like our own lives, the life of a business is not predictable to a very high level of precision. Thus, you buy the business only when it is available at a price well below what you've just valued it at. That difference between the price and value is your safety margin. The idea is that the margin will absorb your miscalculations or bad luck.
  2. Every investor is probably familiar with the second half of the concept - diversification. However, the power of diversification only comes alive when used in conjunction with the safety margin. This is because even when you factor in a margin of safety while buying a stock, the result of that investment may still be bad. The margin ensures only the odds are in your favour in that investment, not that you will never have a loss on it. However, as you increase and diversify your investments with a margin of safety, the probability that your total profits will exceed your total losses becomes very large indeed.

These two halves of the concept of margin of safety, when put together, become a very powerful positive force for your investment results.

The world is full of investors and analysts who lay claim to perfect visions of the future - to being able to predict the future of a business to the smallest percentage point. Such confidence in their own abilities to estimate the future means they incur losses if their estimates don't come true.

Do not be party to this folly. Be humble about your ability to estimate the future of a business. Always invest with margin of safety as if your life depended on it. As simple as the concept is, you will come to realise its power to deliver profitable results over your investing lifetime.

Buffett surely has.

Now, you are probably thinking that this is all theory... But it's not. It actually works in the real world. And here's how you could make this approach work for you too...



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------------------------------

02:55

The big bang IPO of ICICI Prudential Life saw a lot of firsts. Here's one more. With this IPO, the total capital raised through IPOs crosses the Rs 200 bn mark in 2016. What more, the IPO fund raising also hits a six-year high as the last time more funds were raised was in 2010 when an all- time high of Rs 375 bn were mopped up. Will we break this record in the remainder of the year? Well, looks unlikely. We can certainly come quite close because if a leading daily is to be believed, deals worth Rs 100 bn are waiting to hit primary markets.

While our general pessimism towards them is quite well known, we do think there are a select few that are fundamentally strong and also leave some money on the table for investors. In order to have a great shot at identifying the right ones, do check out our special report titled The Handbook of IPO investing. Besides providing a checklist on how to identify the right IPOs, it also has a special focus on analyzing insurance stocks and how to go about valuing them. We are sure you will come back with some new insights. Click here to get your free copy right away

IPO Fund Raising is at a 6-year high

03:50

Did you read Bill Bonner's warning yesterday about Selling Stocks and Buying Gold. His argument is simple. Whenever the Dow Jones index is worth less than 5 ounces of gold, it is time to buy stocks and sell gold. And when the index is worth more than 10 ounces of gold, do the reverse.

As per Bill, the ratio is well above 10 right now and therefore his recommendation on selling stocks and buying gold.

Bill is not the only gold bull in town though. An analyst who answers to the name of Diego Parrilla and who's worked at Goldman Sachs and Bank of America Merrill Lynch earlier, feels that the yellow metal is at the start of a multi-year bull run with a 'few thousand dollars of upside' in a world lf 'monetary policy without limits'.

Unlike Bill though he is not expecting only the stock bubble to burst. He is of the view that asset bubbles will burst in everything from bonds to credit and equities. This will then force investors to find a safe haven with gold emerging as the most popular asset class of choice.

Fortunately or unfortunately, we may not want to contest Parrilla's claims. As central banks keep printing money and allow interest rates to remain lower for longer, the lesser becomes the possibility of a smooth unwinding of all of these excesses. The resultant implosion in all asset classes could certainly send people looking for safe haven like gold and push its price higher.

04:25

As you know, Vivek Kaul recently launched The Vivek Kaul Letter, which is a unique kind of newsletter, the first of its kind in an Indian context. It is an effort that will help you to stay on top of big macro trends in India. The ones that could directly impact you and your family. Vivek will be addressing a range of big issues - such as the government's handling of oil prices, the mess in public sector banks, the current state of India's real estate bubble...and a lot more!

In fact, as you read this, Vivek has just come out with a video that details all...including how this trend could impact you.

Click here to know more.

04:35

Meanwhile, Indian markets are trading strong today with the Sensex higher by 240 points at the time of writing. Mid and Small Cap indices were also pretty buoyant, trading higher by 0.9% and 0.7% respectively. Amongst sectors, banks and energy were seen attracting a good amount of investor interest.

04:50 Today's investment mantra

"You leave yourself an enormous margin of safety. You build a bridge that 30,000-pound trucks can go across and then you drive 10,000-pound trucks across it. That is the way I like to go across bridges". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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