The importance of a margin of safety and the alignment of interests in 2004

by Ashik Shah on 31 January 2004

Whether investing in a private or public transaction, Kurm is looking to invest for the long-term on a value basis. The management must have a significant stake in the transaction for them to be motivated to think like owners: most of the time, they are already significant owners. The management must have a track record of shareholder-friendly capital allocation, as well as an excellent record in the industry. Our recent investment reflects these principles, as does a prospective investment in which we have been offered participation, of which you will hear shortly, should anything materialise.

In addition to the criteria listed above, the integrity of management is paramount. Recent events in the corporate world have, again, cast light on the somewhat murky ethical standards of those to the public entrusts its money. It is hardly possible to imagine how auditors and regulators not to have noticed such a gaping hole in Parmalat’s balance sheet, let alone the major failure of ethics.

We have already discussed many other problems faced by investors over the years, including recent “market timing” scandals and the mis-selling of so-called guaranteed products, enhanced by gearing. In the former case, the interests of the small investor were sacrificed for the benefit of larger investors; in the latter case, the small investor was led to believe that their capital, and sometimes profit, was guaranteed, to discover – all too late – that this was not the case, when “market value adjustments” have now begun to be applied.

Given all this, and the problems many faced after the recent boom and subsequent bust, it is not surprising that many investors are at a loss. However, what is more surprising is the renewed confidence many have after the recent rises in markets. Many shrewd investors have clearly stated that they are finding it difficult to understand the valuations at which many companies are trading. This suggests grounds for caution.

Having said this, there are usually always some investments which can be made profitably, and with some limit to the down side. This leads to another key principle of investing: price discipline. No matter how well a business is run, and no matter how much profitable growth it might achieve, the investor will not benefit if he overpays. Indeed, when we invest, we are always trying to do so with a “margin of safety” where we believe that our investment is being made at a price less than the intrinsic value of the business.

As long as Kurm continues to invest with able, honest managers and with price discipline, your investment is likely to out-perform the markets over the long-term. While this long-term value approach requires patience and may not be considered as dynamic, I believe it is a proven system for preserving and growing capital.

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The views expressed and comments made on this website are not personal advice based on your circumstances. The purpose of this website is to provide information and analysis to help you make your own informed investment decisions. If you are not confident making your own investment decisions you should contact a firm which is authorised and regulated by the Financial Conduct Authority (such as Ashik Shah & Co. Ltd.) so that a qualified financial adviser, after considering your personal circumstances and investment objectives, can make personal recommendations of investments which are suitable for you. Whether you make your own investment decisions or prefer to follow the recommendations of a financial adviser you should always remember that your capital will be at risk and that investments can go down in value as well as up.

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