Round Hill
Asset
Management, Inc.
Registered Investment Advisor
Round Hill
Asset
Management, Inc.
Registered Investment Advisor
Benjamin Graham defined "margin of safety" as the discount from "intrinsic values" at which a security may be purchased in the open market. If a company has an "intrinsic value" of $100 per share, an investor who buys the company's stock at $55 per share will have a "margin of safety" of $45 per share. This investor will have a potential return on investment equal to the "margin of safety", assuming that this company's intrinsic value of $100 per share will ultimately be realized. Thus, the potential return of $45 per share on an investment of $55 per share is 82%. If the same stock could be purchased for $40 per share, the investor's margin of safety would be $60 per share, and the potential return on the investment of $40 would be $60, or 150%.
The preceding example demonstrates that as the margin of safety increases, the potential return also increases, while the investor's risk decreases. This concept of an inverse relationship between risk and reward contradicts the common precept that risk and reward are directly correlative. Round Hill's investment approach clearly incorporates an inverse relationship between risk and reward.
By rigorously adhering to Round Hill's investment criteria, a managed account will be more fully invested in equities at relatively low stock market levels and progressively less invested in equities as the stock market rises. This change in the overall level of investment occurs because many securities may meet Round Hill's purchase criteria when the market is low. When the market is higher, however, many securities may be sold as their market prices approach their intrinsic values. As a result, Round Hill clients typically hold more cash when the market is higher, and less cash when the market is lower, even though no attempt is made to predict the direction of the market.
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