The Business of Value Investing.pdf

34 The Business of Value Investing

of construction and insurance. Even if the houses only were

to get back to a value of $ 1 million in a couple years, you would

still do very well. The process behind this purchase is completely

rational. You paid $ 400,000 for an asset that was selling for $ 2 mil-

lion. Because the discount was so wide, you weren ’ t concerned with

whether the price would ever again reach $ 2 million. Your mar-

gin of safety was so high that even at a sales price of $ 1 million two

years later, your total return would have exceeded 100 percent, or

a return on investment of over 25 percent a year. The numbers are

quite good even if the fi nal sales price was $ 750,000.

The key point is that in a situation like this you wouldn ’ t just

buy one property if you had the means to buy more. Seeing the

tremendous discount between market price and fair price, you

would seize the opportunity to make a substantial investment. But

you would also want to seize the opportunity in a sensible manner.

You ’ re not going to lever yourself up to a point where you don ’ t

give yourself ample time for the market to correct and attract buy-

ers. This is your margin of safety in this investment. This is Hawaii,

where everyone dreams of owning beachfront property and it is a

matter of when, and not if, the values rise back to normal.

You should have a similar mindset when investing in businesses

via the stock market. If your analysis suggests that a quality business

is selling for a bargain price and that sooner or later the price will

rise to catch up with value, you should be excited at the opportunity

to bet big, as such opportunities (like buying a $ 400,000 beachfront

Hawaiian house) are very rare. At the same time, you don ’ t want to

invest with money you don ’ t have by using funds borrowed on mar-

gin. The instant you make slam - dunk investments using proceeds

from your broker, the rules of the game have changed. You give up

any margin of safety the minute you expose yourself to redemption

calls from your broker. Similar to our real estate analogy, it may take

many months for the market to agree with your investment analysis,

but if you ’ re forced to sell in the interim in order to satisfy broker

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