Margin of Safety

Benjamin Graham, father of value investing, once distilled the practice of sound investing into three words:  margin of safety.

Margin of Safety in Flight

Margin of safety isn’t unique to investing.  The aviation industry is steeped in margin of safety practices.  Manufacturers build aircraft designed to fly within a specific range of maneuvers imparting stress on the airplane.  These maneuvers and associated stress limits are established and documented by the Federal Aviation Administration.  

Aircraft are built and certified to operate well beyond these limits to account for unexpected weather conditions and poor pilot decision making.  Building to withstand more than the published limits of the airframe imparts a margin of safety to flight operations. 

Airlines, corporate flight departments, charter operators, and flight schools are conscious of margin of safety as well.  Aviation firms use decision tools and training methods to help ensure flight crews conduct operations within safe limits.  Best practice includes risk assessments prior to takeoff to thoroughly documented and verified procedures used during each phase of flight.  Standard practice focused on safe flight operations add a margin of safety to any flight.

From the time pilots begin their initial flight training, nearly everything they work through is designed to build a foundation of good aeronautical decision making and safe operating practices.  Pilots learn about the design limits of their aircraft and how to fly within those limits.  They build skill through regular simulator sessions providing the repetition and critique unavailable in an actual airplane.  These activities are required of all airline flight crew on a regular basis.  Good decision making with highly developed skills built through repetition and critique add yet more margin of safety to flight ops.

What’s aviation got to do with investing?  Dividend Farmers want to build a margin of safety into our investing the same way aviation firms build margin of safety into their operations.  We look for well designed and built firms in which to invest.  Our target companies are large, have long records of cash generation, don’t carry far more debt than equity, and aren’t priced too far above their intrinsic value.

These firms exhibit logical, easily repeatable operating practices that don’t expose investors to undue risk.  Management teams make logical decisions, don’t gamble, and take only well calculated risks.  Firms headed in such fashion are likely to produce reliable results while avoiding big losses.

Investors who understand these factors, know the fundamentals of investment analysis, and practice their craft regularly, build investing skill through repetition.  As our skills build so does our ability to develop margins of safety within our investment choices.

The first rule in aviation is to not lose life – yours or anyone else’s.  In investing, the first rule is  to not lose money.  The second rule in both is the same – remember rule #1.

Although few people become pilots, millions become investors in one way or another.  Creating a margin of safety is a priceless activity regardless of the industry.  You expect a healthy margin of safety whenever you board an airplane.  Why not expect the same with your investing?

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.