No. of Recommendations: 93
Margin of safety,

Back in 1979, I got my first lesson on margin of safety, long before I ever heard of Benjamin Graham. I was investing as a blind sheep back then.

At the time I was a co-pilot in the Air Force, flying KC-135's. Another base had just had a crash where the crew died. Our Wing Commander came in to talk to the crews who were sitting alert. He was Col. Harry Johnson. He probably saved my life.

Col. Johnson came in the room visibly upset. You see, the crew probably died unnecessarily. They didn't use a margin of safety.

He said “Look guys, I know you don't like me much…but listen to me now. If you listen to nothing else, listen to this.”

He held his right hand about chest high and said “This is your flying ability.” He held his left hand about stomach high and said “This is where I want you to fly.” The difference is your margin of safety. The distance between the two hands is what keeps you alive.

“Sometimes things will happen that will use up your margin of safety. These are generally unforeseen events. Bad weather. Broken airplane, or a fight with your wife. I never want you to intentionally use any of this margin of safety to complete the mission. I'd rather you came home alive so you can complete the next mission.”

I distinctly remember a crewmember laughing on the way out about the speech. He later died in a crash in Ohio. A spectacular crash where the aircraft came apart in the air. Instead of pilots, two of the crewmember's wives were in the seats. Not a single pilot had access to the controls. I'd suggest they used up their margin of safety.

How did he save my life? One night, I was on final approach at Plattsburgh AFB in upstate New York. The wind was calm on the ground. But in the air, our groundspeed was 70 knots faster than our airspeed. This indicated a loss of 70 knots of tailwind on final. This is a very dangerous situation because to land safely it requires a great increase in power as you lose the tailwind to slow your rate of descent. Nothing else was wrong.

I wasn't that great a pilot. I didn't have the stick and rudder skills of most other people. So my margin of safety was always large. I elected to take the approach around. On the radios I announced that I suspected there was a severe windshear on final. This causes planes to crash. The supervisor of flying publically chastised me on the radios for taking around a perfect approach while the winds were calm.

Rich came in right behind me. He was an excellent pilot. An instructor in stan eval (Which means he gave checkrides to other pilots.) The runway probably still bears the imprints from the landing. You see, it was a somewhat controlled crash. The landing gear was pushed a bit into the wings. The crew was ok, thanks to the stick and rudder skills of the pilot in averting a worse crash.

What does this have to do with investing? Ben discussed margin of safety. The distance between your hands. It is what keeps you alive when you encounter unforeseen events. Use it in driving, flying, everything you do, even investing.

Take a company like HD. They are probably fairly valued if everything goes perfectly for the next 15 years. But most likely there are other companies that are undervalued even if a few things go wrong.

An old pilot saying. “Use your superior knowledge and wisdom to avoid situations that require the use of your superior skill and cunning.”

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