Q. “Timon I read legend, Charlie Munger (Vice Chairman at Warren Buffett’s Berkshire Hathaway Investment company) passed away.  In one of the articles it talks about one of the biggest secrets to building their $772 billion empire was using the power of Margin of Safety. Do you have any information about this method that I can apply to my investing?”

A. Oh absolutely. The margin of safety is often overlooked but its one of the most powerful investment strategies of the century.

Here’s how the margin of safety works and ways to apply it…

The margin of safety is the difference between the intrinsic value of a stock and its market price.

Look at this chart and then I’ll explain the breakdown in simple terms.

1. Intrinsic Value:

This is the estimated true worth of a stock.

It is based on its fundamentals such as:

• Earnings
• Dividends
• Growth rate, and other
• Financial metrics.

It’s essentially what the company is worth.

2. Market Price:

This is the current price at which the stock is trading in the market.

3. Margin of Safety:

The bigger the difference between the intrinsic value and the market price, the larger the Margin of Safety (see the chart).

Buffett suggests that an investor should only buy a stock when its market price is significantly below its intrinsic value (as I mentioned in point 1).

The lower the price is compared to the intrinsic value, means there is a higher chance of the market moving up in value.

Buying a stock with a large Margin of Safety gives the investment plenty of room to perform.

Q. “You mentioned in your Money Morning article that with the drop in interest rates, this will attract more investors to buy stocks which will drive up the markets. Can you tell me a few reasons why this will happen?”

A. Sure, I expect the JSE ALSI to rally, thanks to lower interest rates, here’s why…

1. Cheaper borrowing for companies

When interest rates are low, it’s cheaper for companies to borrow money.
And when they borrow money, they can use it to invest in assets, employ more people and invest in R&D.

This attracts investors to buy the company’s shares, which helps it rally further.

2. Higher company profits

Lower interest rates will also help reduce the cost of repaying debt for companies.
And this can also help boost their profits, which will help make stocks more attractive to investors to buy up.

3. Better Investment Returns

When interest rates drop, thanks to lower inflation levels, this drives investors to exit their interest-bearing assets like bank savings accounts, money market funds and bonds. And invest in higher return assets like stocks, ETFs, and unit trusts.

4. More spending by consumers

Nothing drives markets more than consumers spending on products and services. And when interest rates drop, consumers spend more, driving up company’s revenues and profits.