Do Your Homework

1. Always Insist on a Margin of Safety

Valuation is the closest thing to the law of gravity that we have in finance.  In other words, it doesn’t exist (the law of gravity), but it’s the only thing that matters when a physical body is not resting on the ground.  Therefore, valuation is the primary and fundamental determinant of long-term returns.  In order to generate above average returns, the objective is not to buy at fair value, but to purchase with a margin of safety.  This also works in reverse when one sells an overvalued name – do so with a margin of safety.  This notion reflects the fact the margin of safety provides a much-needed cushion against errors and misfortunes since any determination of a scalar number which is defined as “fair value”, is nothing more than an estimate.  If you disregard the notion of a margin of safety, then you disregard the notion of walking a high wire without a safety net.  Do so at your own peril.

Do Professional Money Managers do their h0mework BEFORE they go long or short?


How much homework?

Well, that depends on the fund.  Many hedge funds will buy or short a little stock, to get them "interested", and then they begin their due diligence (homework) on the company.

Many hedge funds focus on 50 "names" that they know everything about, and then can move quickly should conditions be approproate.

As a result, how do you, as a retail investor, take advantage of that knowledge?

How much due diligence do you need to accomplish?

What type of due diligence do you need to accomplish?
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