The Very Importance of Margin of Safety

The Very Importance

of Margin of Safety

There is a famous rule in investing that is rule number one : Never lose money and rule number two: always remember rule number one.

Unfortunately it is almost impossible not to ever experience losses in stock market unless one is not a human and something else or have a time machine that can go travel back to time or ahead. Or perhaps unless one never invest in stock market at all.

I have my share of experiencing real cash losses in some stocks in my lifetime too. It is never an easy feeling when one cuts losses in a bad investment. The feeling of "hati sakit" is one you know I know.

So one needs to avoid losing money in the stock market as much as possible. If one cannot accept losing money, one should totally stay out from investing and put all his money in Fixed Deposits. At least he can sleep well peacefully every night. Ironically I have a close relative who does that and nothing else when it comes to money matters. He is so conservative and cautious is his approach that he doesn't trust investment at all even though he knew about my interest in investing.

So what kind of strategies should be applied if one wishes to minimise his losses? I do not think there is a standard strategy for this. Rather I believed

many of us would have their own definitions of entering the market based on their version of margin of safety.

Here are two I like to share which again are my own and not necessary suitable or applicable to anyone. But if it works for me, then it is fine.

Buying at near 52-week low or a few years low

Strangely while this sounds easy to understand, it is also difficult to apply because there are always detractors who will advise against this by saying : don't catch a falling knife. But if one waits till the falling knife has landed, then one waits forever unless that particular stock drops to as low as 5 sen or less which is most probably unlikely for most stocks.

As long as that particular stocks continues with its usual profiting business (better still paying some decent dividends usually), buying it near its 52-week low is actually quiet a low risk buy. The stock might still go down to another new 52-week low after one enters, but then again one has already secured a big margin of safety compared to all those who bought above the 52-week low.

If one remembered when oil price was skidding to new lows in late 2014, many stocks were skidding to new 52-week lows. I bought three stocks over a period of three months : Century Logistics Holdings Berhad, Supermax Corporation Berhad and Thong Guan Industries Bhd. Supermax and Thong Guan were trading at new 52-week lows. But what happened today is Thong Guan has more than doubled its share price to above RM4 (and still standing there) while Supermax went to touch a high of RM3.54 in early January 2016 (I admitted I was lucky enough to sell off at RM3.52, no reasons for selling other than to take profits sometimes). Supermax today is trading just above RM2.

As for Century Logistics, it was not exactly trading near its 52-week high, rather I liked for its superior dividends of 5% plus which should support its share price.

Buying when it has fallen substantially from its peak price but not 52-week low

There are times too when we notice a particular stock has been going up higher and higher by the days due to some good news like a recent announced quarterly results. It sounds too tempting if one does not jump in before the price goes even higher.

Normally in this type of case, I feel I might have missed the early boat and now if to buy must pay a higher price. Unless this particular stock's fundamental and future predicted earnings can convince me deep enough, I do not mind entering even at that stage. I had done that before and has been richly rewarded too on numerous occasions. But of course if one is to practise patience and caution, one can always wait for its price to peak at certain stage and allow profit-taking to step in. Then there were be a price retreating period where one must set a target to enter.

A few recent examples were Chin Well Holdings Berhad (which had gone to touch a high of RM2.34 on Jan 7, 2016) which I was interested, but I set a target of RM1.70 if it ever retreated and it did).

Cycle & Carriage Bintang  Bhd (CCB) which soared to nearly RM3.93 on Jan 11, 2016) when it was shared by a few famous bloggers which caught my attention. I waited for it to retreat and my price below RM3.40 which it did.

Another was BP Plastics Holding Berhad (which soared to a high of RM2.02 on Jan 15, 2016). It was a stock I had kept for many many years and sold off at RM1.92 early  this year for a more than 100% profit. I was hoping it would retreat back to a more realistic comfortable level price which was below RM1.60. And it just did when the market became negative for most export oriented stocks later.

So having patience and setting target price for stocks which had surged to new high (but stocks which should be good to keep for longer terms) when there is a retreat can be cost saving and also one has some reasonable big margin of safety in it.

Finally Focus Lumber Berhad which reported a disappointing set of result for Quarter One 2016 (but still a profitable result) saw a massive selling spree which saw its share price spiralling all the way down from a peak of RM3.09 in January to as low as RM1.68 recently. That is a very big retreat of more than 45% which must be one of the most shocking drops for its long term shareholders (including yours truly).

It is currently trading around RM1.70 plus which seems to be its more or less stabilising point where it seems not many are eager to sell any lower or not many are eager to pay more. Note that its 52-week low is RM1.27.

Mind you, Focus Lumber is a good fundamental stock that is cash rich and its dividends has been quite generous when it is able to earn more. So should one enters Focus Lumber now knowing at this stage, the margin of safety is such a massive one of 45%?

It depends on your guts, but I knew a guy has recently bought 3,000 shares of Focus Lumber of July 22, 2016 at RM1.77. If you really care to know who he is, check the latest Kassim's Basket of Defensive Stocks. Dare to follow him again?

Yes, you read it correctly.

I have bought more shares of Focus Lumber

on July 22, 2016 at RM1.77 which is significantly selling at a massive 45% off from its peak price of RM3.09 in January 2016. The margin of safety is even more now.