Value investing is thought to be a loser’s game. In tennis, we have a winner’s game and loser’s game. A winner’s game is a game of tennis where both players are at an elite level. It only takes one mistake for a player to win. A loser’s game is a game of two ordinary people playing tennis. You just wait for the other person to make a mistake. All you have to do is just keep returning the ball.
In the stock market, people seem to be caught up by the idea of the bagger stock. Of getting that stock before it goes big. That is a winner’s game. You are looking for that one big winner. But I think investing in the stock market is a loser’s game, you are avoiding that one stock that could get you.
Ben Graham, with all his wisdom has taught us the margin of safety. If you look at the downside and not the upside, you will always have a chance to get the upside right. If you took care of the downside, the upside will take care of itself. What many people don’t realize is that, investing is is a game of probabilities. There will be times where you will make a mistake. What you want to do is to limit that mistake so you’ll stay longer in the game. Just like how a loser’s game in tennis doesn’t matter how fast you can out your opponent. What’s important is that you are there long enough that your opponent makes a mistake. Its not a sprint, its a marathon.
It is no accident that Warren Buffett’s 3 rules for investing is “NEVER LOSE MONEY” as its first and second rule. The third rule, never forget rule #1 and #2. Buffett has been telling us to look down, not up. Before investing in a company, look at the possible scenarios that you will lose your money and assign a probability to it. If the odds are favorable, invest. But keep in mind that its all probabilities and your outcome does not necessarily mean you made a mistake.
What do I mean by that? If you do value investing, have a margin of safety, but the company went bankrupt, it does not mean that you are wrong. The quality of the outcome (bankruptcy) is not related to the quality of the decision (deciding to invest). Same goes if you invest in something recklessly and it went up, it does not mean that you are right or skillful. The outcome is not the deciding factor if the decision is a quality one or not.
In practical terms, how do we know if the downside is favorable for us? Well, for one, looking for undervalued stocks is the best way to get a margin of safety. If you look at the margin of safety first and foremost before deploying your capital, you will be better than most of the investors that participate in the market. Because fear of missing out is strong and people will tend to risk money just to get higher yields. This is also the time when most people is looking up. But you, as a value investor should be looking down. How far is the fall? How probable is the bankruptcy?
Have you ever experienced being right in a decision but the outcome is not favorable?