Mind the Gap

I think it was Warren Buffett’s mentor Benjamin Graham that first articulated the concept of ‘margin of safety’ as the difference between a company’s market value and its intrinsic value (or the present value of the company’s future free cash flow). A less formal definition of the ‘margin of safety’ may read something like ‘the capacity to be wrong and still do well’. Anywho, the concept of margin of safety goes beyond valuation, capital requirements and profit margins . As expressed in the Big Tides post, an investment’s ‘margin of safety’ is also arguably higher (or lower) for industry segments and/or asset classes at the cusp of seeing a dramatic inflow (or outflow) of capital and the expectation is that this will continue. For example, consider China Mobile (CHL-US) in the early 2000s when Chinese GDP growth was re-accelerating and mobile technologies were starting to be mass adopted in emerging markets. The company looked very expensive on most traditional valuation metrics, but this did not seem to matter when compared to the rate of growth in cell phone use and potential size of the target market.