 Good day fellow investors! We are finally getting to the end of the summary of the Intelligent Investor and today we're going to discuss Chapter 20, Margin of Safety, which alongside Chapter 8 is the most important chapter one should read from this book. So let's focus on the margin of safety. In this video we will explain what is the margin of safety, how to check whether a stock has a margin of safety or not, how large is that margin of safety, the relation between the price and the margin of safety, the importance of diversification even if there is a margin of safety, what about margin of safety and unconventional stocks, secondary stocks as Graham would call them, stocks for the enterprising investors, then a little bit about margin of safety and investing and how it's best to invest when investing looks more like crazy speculation, then we're going to touch on Graham's view on fair weather investments, where you have to be careful, a shocker from Graham discussing options, he discussed warrants in the past and then summing it all up, Graham's view on investing, the four business principles he shares based on his most important quote, investment is most intelligent when it is most business-like. So let's start. The book starts with an amazing sentence which fits perfectly into this market, these two will pass. However, something that doesn't pass and will never pass is investing with a margin of safety. So let's see what is a margin of safety when it comes to investing. For Graham, a margin of safety related to stocks and stock investments is when a stable company, a great company with stable earnings is trading at a price earnings ratio at an earnings yield that is much higher than the current yield you can get from same quality bonds. For example, if a stock is trading at an earnings yield of 10% and you can get 3% from US treasuries of, I don't know, 5-10 year maturity, then the stock has a large margin of safety. If the stock is trading at an earnings yield of 3-4% and you can get 3-4 from bonds or even 5% from bonds, then you might say, okay, there is not such a margin of safety with that stock. For example, Johnson & Johnson has forward price earnings ratio of 15.58 and a cyclically adjusted price earnings ratio that uses 10 years of earnings from 2008 to 2017 of 30. This means that the current earnings yield is around 6.6% from the forward price earnings ratio, but that the cyclically yield is closer to 3% coming from the CAPE ratio. Given the treasuries now yield even more than 3%, there is no margin of safety when buying Johnson & Johnson according to Graham. But Graham says that the most of what investors lose when investing comes from buying secondary companies, not great companies as Johnson & Johnson is, buying secondary companies and paying, let's say, equal market value for those companies. So, if you buy J&J at a 6% earnings yield, the margin of safety is much bigger than if you buy some XY stock that doesn't have the history, doesn't have the mode, doesn't have anything like a great business here. So, there you might lose much more than when buying such, let's say, a blue chip. So, that's something to keep in mind. J&J will be there probably in 10-20 years, perhaps even higher, but there will be fluctuations. And looking at now, there is no margin of safety from Graham's perspective. When the price earnings ratio will be around 10-11, like it was, I think 2 years or 3 years ago, when I first analyzed J&J, it had a price earnings ratio below 15% and the treasuries were yielding 2%. Then, when the stock was also below 100%, there was a relatively huge margin of safety and those who bought did very, very good. The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price and non-existent at some still higher price. So, when it comes to buying bargains that have a margin of safety, you are really buying the past and not that much the future, the future prospects. If those come, those are just a positive, but you're really buying, okay, the past earnings, the stability of the past earnings, compare that to book value, compare that to the treasuries yield and then you can estimate what is the current margin of safety. Now, margin of safety and diversification. Graham really emphasizes the importance of diversification because even if a stock looks like it can have a margin of safety, it can always turn out badly. So, you might see a stock, great company, great earnings, great yields, great past, but you never know what might happen in the future. Think general electric and a huge decline in the stock price. So, if you invest with a margin of safety, it's better to do that in a diversified manner so that, okay, in the global average of your margin of safety investments will lead to a positive return, even if some of those fail, but the long term, the long run will be very positive. If you invest on only one stock and then that one turns out badly, then you will end up miserably. So, you never know what can happen. Always think that the impossible can happen on the stock market, especially with individual stocks, and therefore Graham recommends to be diversified across a various number of great stocks bought at the margin of safety. When it comes to secondary stocks, not blue chips like J&J, but let's say global stocks or more riskier stocks or newcomers, then Graham says that such stock, secondary stocks should be bought at two-thirds of their value or less. Thus, if you compare the margin of safety, what would be their value compared to the market, compared to everything else, compared to the book value, then compared to the tangible book value, then you buy those when there is a margin of safety of at least one-third, which would give you a good protection, whatever happens in the market if the market changes. And discussing what happens if the market changes, Graham says that we have to be very, very careful about fair-weather investments. So, now the economy is doing good, markets are liquid, everything looks amazing, demand is growing, the economy, as I said, is growing, unemployment is low, everything is perfect. So, a lot of businesses, especially with the quantitative easing, we just had a lot of businesses look amazing. But those are fair weather investments. So, beautiful weather, beautiful investment, everything looks good. The point Graham emphasizes is that you should look at those in bad weather. So, what happens to those when the weather changes, when there is no more liquidity, no more easy refinancing, no more growth, when demand contracts, when prices fall, when margins fall, when debt covenants are breached, etc., etc. So, be very careful about investing in such investments that look good with this weather. What happens, always ask yourself, what happens when the weather changes. An example of where the weather changes very fast are Chinese stocks at the IPO, the investment banks market them marvelously, and those are sold at very high prices. But after something happens in China, regulatory, something or growth slows down, the stock price drops like a rock. And then, if you are, if you dare to buy those diversified bargains, if you're sure it's not a fraud, then you might, okay, say, debt sees something to buy. But it shows exactly how different it is. Buying something when it is, let's say, fair weather investment, everybody likes it. And then when things turn south, that's something to be very careful about. A shocker from Graham. Graham says that he talks about warrants. Now we have options in place of warrants that sometimes it is even smart to buy options with a margin of safety. So, if the potential loss of the option is really small in relation to the potential gain, and you see that the underlying stock has the potential to really deliver amazing returns, what Buffett did when he sold those put options on the SAP 500. So, you might also think about options when those are fairly priced and when there is a margin of safety with those options in a diversified portfolio of options, of course, always Graham is always diversified statistically. He's a statistical arithmetic investor. So, that's also an option. It's a shocker, but he did that. And I think if that is your strategy, it's a sophisticated strategy, but you can still do really, really well. To sum up everything, this is Graham's quote. Investment is most intelligent when it is most businesslike, period. And Graham shares four business principles with us that we have to apply when we are investing like business people. You have to first know what you're doing. Don't expect more earnings and dividends unless you know much more about the merchandise, the stock than everybody else. So, be sure to know what you're doing and be sure to compare your knowledge about something with what everybody else knows about that. When you know more, then you can make extra earnings, then you're an enterprising investor. Number two, do not let anyone else run your business unless you can control or have implicit confidence in his integrity and ability. So, really be careful about who runs your money, about whom you have confidence in and be sure to know how to check what they are doing. Three, do not enter upon an operation unless a reliable calculation shows that it has a fair chance to yield a reasonable profit. Keep away from ventures where you have little to gain and much to lose. Perfect example, the marijuana environment. Now, I borrowed this table from the modern who just made an article. So, watch his video about what's going on in the marijuana sector. But very little revenues, very questionable future for all those stocks, very little chance of profitability, especially when the competition kicks in from all over the world and from bigger companies. So, extremely risky, a lot to lose and little to gain. Be careful about that. Number four, have the courage of your knowledge and experience and act on your judgment, even though others might hesitate to differ. You are neither right nor wrong because the crowd disagrees with you. You're right because your data and reasoning are right. So, here Graham says of course, buy when there is blood in the streets if your analysis is right and if you are sure about your analysis. If you do the opposite of the crowd over the long term, it has been shown in history that the greatest investment results are achieved by doing the opposite of what the crowd does. To conclude, Graham says limit your ambition to your capacity. So, do what you know. Now, the stock market SAP 500 will yield about 4% over the next 20 years dividends and earnings growth. If you're happy with that, if that is your capacity, be happy with 3-4% or the 3% treasury that they have now. So, be happy if you want to invest more time, if you want to understand better, then you have to really be in the 1% of the population that puts the 1% work to find better returns. So, it's all about knowledge, work, hard work for Graham and that's how you reach amazing investment returns. There is still one video I will do about Graham and how he reached his amazing returns, which can be a lot discussed whether it was luck or skill. I think it was skill, but please subscribe to check that video too. Thank you for watching and I'll see you in the next video.