How We Think

The Importance of Price

One of our four guiding principles of investing is to be disciplined about the price we pay for any security.  Our circle of competence includes many businesses that possess attractive durable competitive advantages and that are run by capable management.  However, unless the market offers bargain prices, we cannot build in the appropriate margin of safety your capital deserves when deployed.  This concept is vital to our investment program because we will inevitably make mistakes when evaluating the quality of a business or the people running it.

When we evaluate the thousands of facts we can accumulate to predict the future prospects for a business, we are inevitably making hundreds of quantitative and qualitative judgments.  We are judging the strength of balance sheets and cash flows.  We are judging how deep the moat around the business is.  Is this moat getting bigger, or is it shrinking?  Is management being honest with themselves as well as with us?  Etc.  Each of these judgments is subject to some error because information is not perfect.  We have to guard carefully against the psychological misjudgments that would cause correlation in these errors.  Additionally, many endogenous and exogenous factors that we cannot even imagine will affect the future of a business.  One cannot know everything, and some things that are very important may not be knowable.  Nevertheless, when one invests in a company, one makes either an explicit or implicit prediction of all of these factors.

The only prudent way to account for the uncertainty is to keep a laser-like focus on the price we pay to acquire any security in a business.  By this we do not mean that we quibble over a few cents per share when acquiring or disposing of businesses.  We use trading algorithms and strategies to try and achieve the best execution, of course, but the larger principle is that we are only willing to invest in a business when it is so cheap relative to intrinsic value that we have an appropriate margin of safety built in.  Do not be fooled by the fact that you can “calculate” earnings to the tenth of a penny; GAAP accounting is full of accruals and estimates which may or may not reflect actual business conditions.  Intrinsic value calculations are only approximations, so the logical way to reduce the chance of permanent capital loss is to only buy at a substantial discount to our appraisal.  The first rule of investing is to not lose money, so we will not deploy your capital at what we feel to be substandard rates of return for the risk being taken.  Every decision to invest in a company carries an opportunity cost because that capital can be deployed elsewhere in another security or elsewhere in time.  Cash is the great cushion that allows us to sit and wait for great opportunities.  Our mandate is to buy concentrated positions in good businesses at bargain prices — not to own equity securities at any price.  When bargain prices are not prevalent, we will wait patiently.