Benjamin Graham’s

Margin of Safety Concept

Bought for Investment under Normal Conditions!

In the ordinary common stock, brought for investment under normal conditions, the margin of safety lies in an expected earning power considerably above the going rate for bonds. In former editions we elucidated these points with the following figures: 

Assume in a typical case that the earning power is 9% on the price and that the bond rate is 4%; then the stock buyer will have an average annual margin of 5% accruing in his favor. Some of the excess is paid to him in the dividend rate; even though spent by him, it enters into his overall investment result. The undistributed balance is reinvested in the business for his account. In many cases such reinvested earnings fail to add commensurately to the earning power and value of his stock. (That is why the market has a stubborn habit of valuing earnings disbursed in dividends more generously than the portion retained in the business.) But, if the picture is viewed as a whole, there is a reasonably close connection between the growth of corporate surpluses through reinvested earnings and the growth of corporate values.

Over a ten-year period the typical excess of stock earning power over bond interest may aggregate 450% of the price paid. This figure is sufficient to provide a very real margin of safety—which, under favorable conditions, will prevent or minimize a loss. If such a margin is present in each of a diversified list of twenty or more stocks, the probability of a favorable result under “fairly normal conditions” becomes very large. That is why the policy of investing in representative common stocks does not require high qualities of insight and foresight to work out successfully. 

If the purchases are made at the average level of the market over a span of years, 

the prices paid should carry with them assurance of an adequate margin of safety. The danger to investors lies in concentrating their purchase in the upper levels of the market, or in buying non-representative common stocks that carry more than average risk of diminished earning power.

 Why is DYI’s Ben Graham’s Corner

Out of Sync

With DYI’s Allocation of Stocks & Bonds?

DYI:  Today I believe it is to be stated with conviction these are anything remotely close to “fairly normal conditions!”  Whether it be the COVID-19 HOAX or the stage faked death of George Floyd along with the majority of paid looters [all staged for maximum TV presence] along with out of control Federal spending [going into the elites hip pockets] bailing out Wall Street once again.  Massive Federal Reserve policy of driving down interest rates all across the yield curve thus pushing stock valuation back to the upper reaches of the stratosphere!

Normal conditions…I think not!

  

DYI:  Here we are today at 3 standard deviations above the average of the market at almost the same level as the stratospheric valuations in the year 2000!  This chart is calculated comprised from the S&P 500 index.  This index is a bit distorted due to the Giant Five stocks – Microsoft, Facebook, Google, Amazon, and Apple, holding 20% of the S&P 500’s market capitalization.  If these Giant Five Humpty Dumpty’s were to have a great fall in the next bear market this will also distort the S&P 500 on the downside just as it has done on the upside. 

So…Despite this distortion Ben Graham’s Earnings Yield Coverage Ratio is giving us the all clear for dollar cost averaging into the S&P 500 index!  This has come about due to the Fed’s MASSIVE interest rate intervention once again pushing rates down to the sub atomic low level!  DYI’s stock/bond allocation formula is calculated at 100% bonds and 0% stocks!  Both formulas use the Shiller PE.  So what gives??  Simply put the U.S. stock market even discounting the Giant Five remains “jacked up” and when the bear returns stocks will fall mightily!

If the purchases are made at the average level of the market over a span of years, 

DYI:  Today the U.S. stock market is no where close to its average level.  This is a terrible time on a whole sale basis – S&P 500 index fund or generalized managed all stock fund – to purchase stocks.  So hold onto your hats, gold, and cash better values lie ahead.

 DYI