Friday, November 20, 2009

Margin of Safety - Does It Exist?

Benjamin Graham made famous the concept of "Margin of Safety" which basically refers to the price at which an investment will trade that yields minimal downside risk (or acceptable).

At today's stock market valuations there does not appear to be a reasonable "margin of safety". What external market events could cause valuations to contract, perhaps in a severe manner, I've thought of just a few possibilities:

Oil Shock - oil at $200 per barrel (not predicting, but it is now within the realm of possibility through either a falling dollar or a nuclear explosion in Saudi Arabia)

Pandemic - The H1N1 has proven to be more bark than bite (or is that squeel?), but what if it mutates like what happened to cause the Spanish Flu?

Massive California Earthquake (that couldn't happen, forget I even mentioned it)

Bad hurricane season

A major country defaults on its debt, which is widely held (oh wait.....did somebody say Ukraine)

Massive Terrorist attack (or even a small one that strikes the right cord)

Residential and Commercial Real Estate Crash - not the last one, the next one

Global War

Magnetic Pulse bomb

Ben Bernanke re-appointed to the Fed (oh wait.....that already happened!)

Tim Geithner appointed Treasury Secretary (oops.....that happened as well)

Major investment bank reveals massive trading losses due to over-leveraged bets against the dollar or some other asset (this couldn't happen since our banking leaders are at the frontier of managing risk exposure...that was a joke by the way)



Okay, you get the picture. If stocks were trading at 8 or 10 times trailing P/E's perhaps all of the above risks would be worth assuming, however with them trading at 20 times trailing P/E's there does not exist much margin for failure.

The question you have to ask yourself is "Do you feel lucky, Punk?"

Scott Dauenhauer CFP, MSFP, AIF