The Intelligent Investor – Chapter 20 Margin Of Safety Summary
Good day fellow investors. We are finally getting through the end of the summary of The Intelligent Investor. And today we're going to discuss chapter 20 margin of safety which alongside Chapter 8 is the most important chapter one should read from this book. So let's focus on the margin of safety in this video we will explain. What does the margin of safety how to check whether a stock has a margin of safety or not. How large is that margin of safety. The relation between the price and the margin of safety the importance of diversification even if there is a margin of safety. What about margin of safety and unconventional stocks secondary stocks as Graham would call them stocks for the enterprising investors. Then a little bit about margin of safety and investing in how it's best to invest when investing looks more like crazy speculation. Then we're going to touch on Grant's view on fair weather investments where you have to be careful.
A shocker from Durham discussing options he discussed warrants in the past and then summing it all up. Grahams view on investing the four business principles he shares based on his most important quote investment is most intelligent when it is most businesslike. So let's start the book starts with an amazing sentence which fits perfectly into this market. This too will pass. However something that doesn't pass and will never pass is investing with a margin of safety. So let's see what is a margin of safety when it comes to investing. For Graham a margin of safety related to stock stocks and stock investments is when a stable company a great company with stable earnings is trading at a price earnings ratio at an earnings yield that is much higher than the current yield you can get from same quality bonds. For example if a stock is trading at an earnings yield of 10 percent and you can get free percent from US treasuries of I don't know 5 10 year maturity then the stock has a large margin of safety.
If the stock is trading at an earnings yield of free 4 percent and you can get free for 4 on bonds or even 5 percent from bonds then you might say OK there is not such a margin of safety with that stock. For example Johnson Johnson has a price earnings. Forward price earnings ratio of fifteen point fifty eight and a cyclically adjusted price earnings ratio that year was a ten year of earnings from that of to 2017 of 30. This means that the current earnings yield is around six point six percent from the forward price earnings ratio but the cyclical yield is closer to free percent coming from the Cape ratio given the treasuries now yield even more than 3 percent. There is no margin of safety when buying Johnson and Johnson. According to Graham but Graham says that the most of what investors lose when investing comes from buying.
Second the company's not great companies as Johnson and Johnson is buying secondary companies and paying a let's say equal market value for those companies. So if you buy JNJ at the 6 percent earnings yield the margin of safety is much bigger than if you buy some X Y stock that it has doesn't have the history doesn't have the moat doesn't have anything like a great business here. So there you might lose much more then when buying such a blue chip. So that's something to keep in mind. JNJ will be there probably in 10 20 years perhaps even higher. But there will be fluctuations. And looking at now there is no.