Maintaining a Margin of Safety in Your Investment Process
In June of 2021, KCR’s Equity Research Team wrote a brief but pointed review of the legendary treatise on value investing, A Margin of Safety by Seth A. Klarman. With only 5,000 copies of the book in circulation, we hold our copy close but wish to share the wisdom of the billionaire author freely as he intended. Like the work of Benjamin Graham and Warren Buffett, we believe Mr. Klarman’s teachings are a critical underpinning to successfully preserving and compounding wealth.
As the world grapples with a supply chain crisis, dire shortages of fertilizer that put the world at risk of famine, the crisis and fall-out from the attack on the Ukraine and rising interest rates, we believe the benefits of a margin of safety approach have never been more important than today.
In our August 2021 missive, we noted since the start of 2017 Growth had outperformed Value in Large Cap by a significant margin. Specifically, the Russell 1000G rose over 184% while the Russell 1000V rose “only” 118%. This phenomenon is more pronounced in the Russell 2500 Growth and Russell 2500 Value Indexes.
In this piece, we will walk through the following:
- The trailing five year returns to Growth, Core, and Value to explain the analogs to the dot.com mania
- Highlight the severity of current risks we believe are underappreciated by investors
- Offer a very simple way to build a margin of safety into your investment process
Figure 1 below shows the trailing five-year returns to the Russell 2500 Growth, Core, and Value Indexes. Growth rose 125%, trouncing the 60% return to Value by more than two to one. In an environment of loose credit and low-interest rates, we were not surprised to see a speculative fervor grip the nation.
If the Past is Prologue: Why A Margin of Safety in Investments Matters Now