Stock investing can seem daunting, especially for engineers who are used to solving problems with data-driven, structured approaches. But investing is less about following a rigid formula and more about understanding core principles and applying them thoughtfully over time.
One of the most rewarding aspects of investing is the development of multi-faceted skills that extend beyond the stock market. The ability to analyze data, manage uncertainty, and control emotions like fear and greed, builds discipline and resilience. These skills are valuable not only for financial growth but also for navigating challenges in your career and personal life.
As engineers, we excel at structured problem-solving, but the stock market’s dynamic, fluctuating nature requires adaptability. Principles like Margin of Safety provide a steady foundation, but success lies in continuously refining your approach and sharpening your decision-making skills. One of the most effective ways to do this is by adhering to a principle that protects you from downside risk: the Margin of Safety.
Understanding Value Investing and Its Core Principle: Margin of Safety
Value investing is a strategy that focuses on buying undervalued stocks—essentially purchasing assets for less than their intrinsic value. The core principle of value investing is finding opportunities where the price of the stock is below its true worth, providing a margin of safety against market fluctuations.
The concept of Margin of Safety ensures that even if things don’t go as planned, you have a cushion that protects you from significant losses. This approach allows investors to mitigate risk by only buying stocks when they are undervalued, which reduces the likelihood of overpaying for an asset.
By adhering to the principle of Margin of Safety, investors can better balance the emotional extremes that drive stock market movements. This emotional balance is crucial because the stock market is often ruled by fear and greed, which can lead to market mis pricing—valuing companies too highly during periods of optimism and undervaluing them during periods of pessimism.
Ben Graham’s Approach: A Value Investor’s Framework
The concept of Margin of Safety is a guiding principle for all value investors, but perhaps no one embodied this better than Benjamin Graham, the father of value investing. He outlined a framework designed to minimize risk and identify undervalued stocks. Some of his key principles include:
- P/E Ratio of 10 or Lower: Graham recommended buying stocks with a P/E ratio of 10 or below, believing that these stocks were likely undervalued.
- Stocks Priced 50% Below 52-Week High: Graham also advocated for buying stocks that were priced at 50% or less of their 52-week high, which often indicated that the stock was undervalued due to market overreaction.
- Diversified Portfolio of 25-30 Stocks: Graham recommended building a diversified portfolio of 25-30 stocks and holding them for 2-3 years, selling once the stock appreciated by 50% or more.
- Debt to equity ratio of 50% or less: To ensure company has a satisfactory financial position.
These principles helped investors minimize risk and take advantage of market overreactions, both during periods of fear and greed.
The Stock Story: Two Companies in the Same Sector
While Graham’s strategies focus on minimizing risk through concepts like the P/E ratio, diversification, and margin of safety, these principles also highlight how the market’s emotional swings—rooted in fear and greed—can lead to significant mispricing of stocks.
Let’s explore how these emotions manifest in the real world. Now, consider the story of two companies in the city gas distribution sector. They seem to have a lot in common at first glance, but the market is valuing them very differently.
Here’s how they compare:
Company A is more expensive, with a higher P/E ratio and stronger profit margins. Company B is growing faster, with better revenue and earnings per share (EPS) growth. Yet, the market has given Company A a much higher valuation. Why? The answer lies in market emotions—optimism around Company A’s future, despite Company B‘s stronger current performance.
But here’s the twist: Company A and Company B are, in fact, the same company—Indraprastha Gas Limited (IGL). The figures presented reflect IGL’s performance in 2019 (Company A) and 2024 (Company B). Despite IGL’s strong performance in 2024, market sentiment shifted, causing the stock price to fall by 40% and the P/E ratio to drop—illustrating how market sentiment, driven by fear and greed, can lead to mispricing, even when fundamentals remain strong.
My Approach
The emotional swings in the market—fear and greed—have shaped my journey as an investor. Over time, I’ve adapted my strategy, moving from a large, diversified portfolio to focusing on fewer, bigger, and more infrequent bets. This shift reflects my evolving lifestyle and my available time to manage investments. However, the core principles of value investing, especially the Margin of Safety, remain central to my decision-making.
Here’s how my stock selection has evolved:
Focus on Fundamentals: I prioritize companies with strong fundamentals—consistent sales and EPS growth, high return on equity/assets (RoE/RoA), and low debt—as these provide a foundation of financial stability.
Margin of Safety: I look for stocks that are undervalued, e.g low PE multiple, low EV/EBITDA multiple, price to sales, price at multi year low, etc.
Long-Term Focus: I look for companies that have strong, consistent performance over multiple years. I prioritize companies that show stable growth, strong fundamentals, and the potential for long-term appreciation.
Risk Management: I diversify my portfolio across various sectors, include a portion in gold as a hedge, and avoid investing in IPOs or companies with significant promoter pledging or high debt levels.
Despite this shift, the core principles of value investing, particularly the Margin of Safety, continue to guide my decisions.
Conclusion: Learn, Adapt, and Grow
The stock market will always fluctuate, driven by fear and greed, but by focusing on the fundamentals and maintaining discipline, you can navigate these shifts successfully. The story of IGL serves as a reminder that market sentiment can change rapidly, but staying grounded in principles like the Margin of Safety helps investors make rational decisions and focus on long-term success. Investing is not just about money—it’s about developing a mindset that leads to growth, both financially and personally.
Final Thoughts
The stock market will test your patience, but with the right mindset and approach, you’ll be better equipped to handle its ups and downs. Keep refining your process, and remember: investing is as much about self-discovery and personal growth as it is about building wealth.
Resources for Further Learning and Tools for Stock Selection
To dive deeper into value investing and explore stock selection process, here are some valuable resources:
Books
- The Intelligent Investor (Benjamin Graham): The cornerstone of value investing, emphasizing Margin of Safety, intrinsic value, and long-term discipline.
- The Little Book of Value Investing (Christopher H. Browne): A beginner-friendly guide that simplifies value investing with practical strategies.
- The Little Book of Behavioral Investing (James Montier): Insights on overcoming emotional traps like overconfidence and herd mentality, emphasizing rational decision-making.
- The Little Book That Still Beats the Market (Joel Greenblatt): A systematic approach combining high earnings yield and high return on capital to outperform markets.
- One Up on Wall Street (Peter Lynch): Encourages leveraging personal insights and thorough research to identify promising stocks.
- What Works on Wall Street (James O’Shaughnessy): Data-backed strategies showing consistent success with factors like low P/E and high dividend yield.
- The Superinvestors of Graham-and-Doddsville (Warren Buffett): An essay showcasing how Graham’s principles led to consistent success for disciplined value investors.
- Poor Charlie’s Almanack (Charlie Munger): A collection of Munger’s wisdom, focusing on mental models, multidisciplinary thinking, and applying rationality to investing and life decisions.
Tools for Stock Screening
To apply the principles of value investing and screen for undervalued stocks, platforms like Screener.in are incredibly helpful. With Screener, you can filter stocks based on various financial metrics like P/E ratio, price-to-book ratio, and earnings growth, aligning perfectly with the concepts discussed by Graham.
Quiet Reflections 