In this concluding chapter, we will tackle some important points that could shape how you make your investment decisions. In the preceding chapter, we discussed the Discounted Cash Flow (DCF) analysis and its capacity to measure a company’s stock’s intrinsic value. While the DCF process is often considered the most reliable approach available, it can have its shortcomings. Remember that any wrong assumptions used might lead to imperfect calculations of the fair price and stock cost.
The DCF model could be a hindrance, since it is built on limited parameters, leaving you unable to take advantage of unique offerings.
Rather than being restricted to the same, one can try to overcome the drawbacks of the DCF Model by making conservative assumptions. Here are some tips and suggestions for the same:
– Margin of Safety
Despite making conservative assumptions, you can never be 100% sure that things won’t go wrong. To provide protection against that risk, the concept of Margin of Safety should be applied. Benjamin Graham’s well-known work, “The Intelligent Investor”, popularised this strategy, which suggests to buy stocks at a discounted price when compared to their intrinsic value. Following the Margin of Safety doesn’t necessarily guarantee success, but it does provide a buffer for errors in estimations.
I adhere to the Margin of Safety principle when I invest. In the case of Amara Raja Batteries Limited, we estimated its intrinsic value to be Rs.368/- per share. We then looked at this figure with a 10% modelling error in mind – that is, we set the lower intrinsic value estimate at Rs.331/-. To be safe, though, I aim to discount the intrinsic value by at least another 30%, creating a bigger margin of safety for myself and better protecting my investments.
Why should we be ultra-conservative? You may question this approach, yet it is the best way to protect ourselves from dangerous expectations and misfortune. In light of all the basics, if a stock looks attractive when priced at Rs.100, then a lower price of Rs.70 only confirms itself as a great investment! This is precisely what seasoned value investors do.
Going back to the case of ARBL –
When quality stocks are trading at substantially discounted rates, value investors will swoop in to capitalise on the opportunity. Therefore, investors should act quickly when the margin of safety is in play. As a long-term investor, one should not overlook such attractive offerings.
Bear markets can offer great discounts on good stocks – so make sure to have some cash handy! These are typically times when people are quite pessimistic, so it’s a great opportunity to pick up some quality investments.