Margin of Safety
October 25, 2011
– Comments (12) |
RELATED TICKERS: AAPL
, AMZN
, NFLX
This is a simple concept.
If you buy a Bentley off the showroom floor for $1 million, you expect every stitch in the leather to be perfect.
If you buy a 1998 Honda Accord off a used car lot for $2500, you do not expect every stitch in the leather to be perfect.
If you buy a Bentley, you are out $1 million, so you had better do a heck of a lot of diligence - make sure every stitch in the leather meets your expectations - before you buy it.
If you buy that Accord - well, it was $2500. You don't expect the leather to be perfect. Maybe it's got cloth seats. You expect it to run, maybe belch a little smoke from time to time, break down on the side of the road once a quarter or once a year.
If you buy Amazon at a P/E of 100 and they stumble, making only 14 cents instead of 51 cents per share - well, that ain't no Bentley. It's just a BMW. You might lose 12 percent of the price. Now your P/E is 88.
If you buy Netflix at a P/E of 100 and it breaks down on the side of the road and the mechanic tells you he's going to try to fix it, but he can't be sure but what it is never going to go over 50 mph again, you might lose 75% of your value on that Bentley because, turns out, it's not even a Honda. It's sort of a beat up Geo Metro with a salvage title.
AAPL's P/E (cash adjusted) is 13. INTC's P/E is 10. NFLX after the beat down is 17.5. AMZN after the beatdown is 88.
Do any of them make a car you'd want to drive? Now, how much would you like to pay for that ride? How much due diligence do you want to do? How much of a beat do you expect from a miss?
That's margin of safety.
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