Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

CHAPTER 2

SEEKING A MARGIN OF SAFETY AND VALUATIONa

Matthew B. McLennan, CFA

The foremost goal of investing is to avoid the permanent impairment of capital, which we believe can be done primarily by investing in companies that provide a margin of safety. Cash and gold also play unique but significant roles in our portfolios that are designed to preserve real wealth.

Nearly two decades ago, my wife and I visited a Buddhist temple on the west coast of Japan. As we walked into the monastery, we were approached by a monk with a piece of paper in his hand. My Western mind-set assumed that he was handing me a nondisclosure agreement or a release of liability, but instead he was holding a sign, written in Japanese, that said if we were to go into the temple, we had to do so with an open mind.

An open mind is also an essential element in the concept of margin of safety. A margin of safety is more about mind-set than it is about any specific algorithm, model, or set of precise inputs. It is about temperament. In my presentation, I describe the mind-set that we have embraced at First Eagle for defining and applying the concept of a margin of safety to help preserve value over time for our clients.