Margin of Safet...'s  Instablog

Margin of Safety Investing
Send Message
I am a private investor building a value focused portfolio. While I do not work directly in investing, I do have a financial background and hold the CFA designation. The goal of Margin of Safety Investing is to share my investing journey as I review and analyze investing opportunities using a... More
My company:
Margin Of Safety Investing
My blog:
Margin of Safety Investing
  • Weekend reading with James Montier: The trinity of risk 0 comments
    Oct 29, 2010 5:02 PM

    I am very happy to share with you the article that has been the base for my quick reviews: The trinity of risk by one of my favorites: James Montier

     

    In this article argues that value investing is the “only investment approach […] that puts risk management at the heart of the process” and by this he means the risk of permanent loss of capital.

     

    Re-shuffling the risks to mirror the order in which I look at them in my quick reviews, we have:

     

    1-       Business risk: which using Graham’s quote is: “the danger of a loss of quality and earnings power through economic changes or deterioration in management”. In order to evaluate this risk and get a sense of strength and stability of companies, I review their cash generation, returns on equity and assets and growth. I also evaluate management’s shareholder orientation through a review of their uses of cash.

     

    2-       Balance Sheet risk: Here Montier suggests using Altman’s z-score as a good measure of health. In my framework I may be a bit more stringent, usually requiring a Debt/Equity ratio below 1.0x.  If the company seems promising enough that I perform a longer analysis I also review Altman’s z-scores but given my requirements beforehand z-scores in my analyses have so far turned out to be good (over 3.0x)

     

    3-       Valuation risk: using again a quote from Graham to introduce the idea: “The danger in… growth stock(s) [is that] for such favored issues the market has a tendency to set prices that will not be adequately protected by a conservative projection of future earnings”.  Graham (and Montier) often used what is now called the “Graham and Dodd P/E” or the P/E using 10-year average earnings. Graham put a line in the sand in terms of maximum valuation he was willing to invest at: “We would suggest that about 16 times is as high a price as can be paid in an investment purchase of a common stock”.  In my quick reviews I look at both P/E (NYSE:TTM) and cash returns (enterprise value / Free cash flow) to get a sense for valuation.

     

    What metrics do you use to evaluate companies along these and maybe other dimensions?

     

    Have a great weekend!

    Ben

     



    Disclosure: No position
Back To Margin of Safety Investing's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (0)
Track new comments
Be the first to comment
Full index of posts »
Latest Followers

Latest Comments


Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.