30 The Business of Value Investingthe world like Coke. For years, it seemed as if fi nancial institutions
could continue to deliver solid, consistent results, but the fi nancial
funk that began in 2006 and has thus far not let up in late 2008
proves otherwise.
Notice the meaningful gap between the current price of
Mohawk shares and the intrinsic value derived from my assump-
tions. This gap is meaningful because it offers a strong cushion
for any errors or overtly wrong assumptions in my analysis. In value
investing circles, this safety net is known as the margin of safety, a
concept developed by Ben Graham in Chapter 20 of The Intelligent
Investor. Two investors will never arrive at the same value for a busi-
ness, because no two investors will have the identical set of assump-
tions. For this reason, any intrinsic value fi gure for a business always
will be an approximation, never a precise number. Requiring a mar-
gin of safety is a necessity if an investor demands preservation of
capital. Ben Graham succinctly summed it up: “ Confronted with a
challenge to distill the secret of sound investment into three words,
we venture the motto, Margin of Safety. ”^8
What is an adequate margin of safety? No set rule of thumb
defi nes how wide a gap should exist between market price and the
true value of a business. Some investors look for a margin of safety
equal to twice the current market price. Again, it ’ s most benefi -
cial to think in a businesslike manner. A superior business with a
dominant competitive position should not require as high a mar-
gin of safety as a smaller, less dominant business. It is much easier
to accurately forecast the cash fl ows of businesses such as Mohawk,
Kroger, or Home Depot than it would be for businesses such as
Pacifi c Sunwear or Bare Escentuals. While no cash fl ow forecasts
will be spot - on accurate, your probability for a wide margin of error
is smaller when looking at stronger, well - established businesses. For
Mohawk, if my assumptions had led to an intrinsic value fi gure of
$5 0 per share instead of $ 83, I would consider that an inadequate
margin of safety. If they had led to a fi gure of, say, $ 70 to $75,CH002.indd 30CH002.indd 30 9/2/09 11:06:28 AM9/2/09 11:06:28 AM