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Today I'll be sharing the importance of building a margin of safety into your investments.

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Now for today’s piece:

Why Having A Margin Of Safety Is Critical

Highlights

My stomach sank to the floor as thousands of memories were gone forever. I was devastated.

But let me start from the beginning.

Two weeks ago I was getting ready for my trip to Seattle (more on that later) and I was moving pictures from my camera’s SD card onto my hard drive to make space.

I’m an avid photographer and I was ecstatic to see what pictures I could capture while on my trip.

While I was moving my hard drive to another room I dropped it from a height of about 3 feet onto a carpet floor. I thought nothing of it since it was a soft fall so I grabbed it and went upstairs.

Later on, I plugged the hard drive into my computer but my computer wasn't recognizing it. On it were thousands of photos from my last 3 years of adventures and at first I was devasted that I lost all of those pictures.

But then I remembered – I made copies on my computer! I'm saved!

I logged into my photo library on my computer and the tears started rolling.

Everything in my library was completely gone. Over 10,000 pictures.

Devastated wasn’t even the word.

I thought to myself, “How could both of my backup plans fail?”

I always think of a backup plan, but a backup-backup plan? I never thought it would come to this.

What Does This Have To Do With Investing?

I’m glad you asked.

In investing, things often don’t go as planned. Generally, we investors are an optimistic bunch. If we weren’t hopeful for the future, why would we invest?

But, not every chart is up and to the right, and not every stock goes up as soon as you buy it.

It’s wise to plan for when things don’t go exactly as planned, and that’s where building a margin of safety comes in.

A margin of safety is like a parachute for a passenger on a plane that’s about to crash.

It's your safety net for when the stock market crashes or your protection for when the price of a stock you just bought nosedive.

Margins of safety aren’t only for investing. You can build up a margin of safety to protect against the possibility of losing your job or to prepare against unexpected emergencies.

For the purposes of this newsletter issue, we’re going to delve deep into how creating a margin of safety can help with investing.

How Can You Best Create A Margin Of Safety?

To create a margin of safety for your investments, I can offer a few tips that have worked for me.

First, I do my best to find a stock’s intrinsic value. There are many ways to do this. The 2 most common ways are:

1. Conducting a Discounted Cash Flow Model (DCF)

2. Using Valuation Multiples

I use a combination of both DCFs and Valuation Multiples to arrive at an intrinsic value, and I’ll be covering my process in next week’s issue.

After I find a firm’s intrinsic value, I create my margin of safety by deciding how much of a discount to the intrinsic value I’d like to buy shares at.

In most cases, I like to buy shares at a 10% discount to the intrinsic value, and that’s my margin of safety as it relates to price. I may adjust that percentage based on how risky I feel investing in a certain firm is.

Is Price The Only Way To Build A Margin Of Safety?

In my opinion, no.

I think you can build a margin of safety by not allocating too much of your portfolio to any one position.

An investment might look like a no-brainer, and it might seem tempting to want to put all of your money into it.

However, putting your entire portfolio into one stock is extremely risky. If something were to go wrong with that one company, your entire portfolio would suffer.

The same goes for if you only buy stocks in one industry. Personally, I hold a few tech stocks that I think will define the future we live in. But as we’ve seen during the Dot Com Bubble and during 2022, tech valuations can get out of control and be swiftly crushed in the market. If I only invested in tech stocks, my portfolio would’ve blown up.

By diversifying across different companies in different sectors, you can build a margin of safety within your portfolio.

Final Thoughts

A margin of safety helps protect against what could go wrong in the world of investing.

Maybe you calculated the wrong intrinsic value, or maybe the market takes a nosedive.

Or maybe the business you bought into starts making questionable moves and you're not happy with their decisions.

In any case, having a margin of safety will help protect you from the unknown. They should minimize your downside, maximize returns, and give you peace of mind.

Just remember to find the intrinsic value, develop a margin of safety, stay patient, and wait for your buy zone.

One tip I can offer: Research companies that you find interesting, even if you know the shares are overvalued. That way if the price suddenly reaches your buy zone, you’re ready to take advantage!

Happy Dividend Investing!

Sincerely,

Dr. “Margin Of Safety” Dividend

Pictures From Seattle

I had an absolute blast in Seattle, visiting everything from the Space Needle to Olympic National Park (on probably the worst day of weather ever!)

I also got spoiled with the best coffee I’ve ever had and now every cup I have back home just isn’t the same.

Anyways, here are some of the best pictures I took:

I’ve thought about starting a travel blog/newsletter sharing my photos and short stories from my travels. If there’s enough interest I’ll start one. Just let me know in the comments or reach out to me directly!

Links And Memes

Here are some of the best things I saw this week:

• A special cup for use in zero-gravity – If given a chance, would you go to space? (Fascinating)

• An inside look at the craftsmanship of Louis Vuitton products – The more I dig into LVMH, the more I want to become an owner (Louis Vuitton)

• A deep dive into the method of valuing a mining company – I believe mining will become much more important as we strive for a green future. I don’t have much experience with mining companies so I’m looking forward to learning more (Brandon Beylo)

And of course, some memes:

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