YouMaketheCall 143Believers in the modern finance stories discussed earlier, for exam-
ple, multiply the market risk premium by a stock’sβto come up with
an appropriate discount rate.
All this disagreement and the examples we’ve just gone through
show you that there is plenty of play in the valuation enterprise. Tiny
variations in your assumptions take the bottom line in widely differ-
ent directions and magnitudes. A 1% change in your guess about the
market premium, for example, throws off an appropriate level for the
S&P Index by about 200 points (and more if you also play around
with your estimate of future earnings growth rates).
Your best approach remains artistic judgment rather than sci-
entific precision. Phil Carret made it one of his investing command-
ments to “ignore mechanical formulas for valuing securities.”^10 Sorry
to disappoint you if you expected magical solutions and think you
haven’t gotten them. In a sense, though, magiciswhat you get.
Graham delivered the silver bullet of investing when he said the
three most important words in investing philosophy are “margin of
safety.” Recognizing that it is essentially impossible to pinpoint the
precise intrinsic value of a business an dthat the best you can do is
compute reasonable ranges of value base don reasonable assump-
tions, Graham thought you shoul dgive yourself a break by making
sure the price you pay is way lower than the low en dof your valu-
ation estimate.
Graham calle dthe margin of safety the central concept of in-
vestment because its essential function is to render an accurate es-
timate of the future unnecessary. In using it, you nee dnot stress or
struggle over the precise way to define the “right” risk premium,
earnings, or discount rate so long as you have a reasonable approx-
imation of what makes sense. Its secondary function is to absorb the
effect of error in your assumptions—an dremember, even tiny errors
cause huge effects—as well as the effect of plain ba dluck.
Graham observe dthat most investing errors are ma de not so
much by paying too high a price for high-quality stocks as by buying
low-quality stocks during times of economic prosperity (much as in
early 2000s America). Indeed, Graham repudiated a strategy that
overemphasizes what the fashion plates of finance call growth stocks.
If you can get the same margin of safety by carefully estimating the
future of growth stocks, more power to you, but the danger is that
growth stocks ten dto be favorites an dfavoritism in stocks is mea-
sure dby high prices that steal safety margins.^11