The second reason we must buy this is to assure us a profit. It has been proven that the intrinsic value will eventually “shine through the mist,” so to speak; the price and the intrinsic value, though they can be vastly different, will converge over a long period of time. Thus, the market acts as a voting machine in the short term, so prices can be all over the place. But, in the long term, the market is a weighing machine; the real, intrinsic value will come to light and be reflected in the price. However, it is not exact, so we must buy significantly below; we need to be in a good ballpark. Perhaps the price will never reach the intrinsic value, but it does reach slightly below it. If we had bought slightly below the intrinsic value, we would still be getting a deal in value, yes, but we would never realize our profit. If we bought significantly below, however, then we would realize a profit.
To understand safety, let us take a look at the margin of safety concept. Since we are concerned with the intrinsic value of the stock or real estate, we are not concerned about its price, which can be anything, as it comes from the sentiment of the general market. The only thing we are concerned about is losing value. When we buy significantly below the price, say, we buy a piece of property at eighty percent of its intrinsic value, and then the property prices can drop a whole twenty percent before we lose any value. This difference between the price we buy and the intrinsic value serves as a sort of cushion which buffers us from any drop in price.
There exists in all investments an intrinsic value of some kind. This value is a dollar amount, and it is what the investment is “really” worth. The investment may not be worth this amount at any given time because of market conditions, but it does still have this intrinsic value. The intrinsic value is based off of facts, not opinions. It is based off of quantitative information, not qualitative. When we examine a piece of stock, we calculate the intrinsic value based on the amount of assets a company owns minus the debt against it. What is leftover is divided by the number of shares, and each share then has its intrinsic value. Another approach for determining the value of stock is the excess of expected earnings and dividends for a period of years above a normal interest return. To determine the intrinsic value of a piece of property, we can multiply its monthly income by one hundred. This will give us a number to work with.
An investor, on the other hand, knows that nobody can predict the future. Those who seem to are merely lucky. An investor is somebody who buys an investment as defined by this definition, written by Benjamin Graham: “An investment is something which, upon thorough analysis, promises both safety of principle and an adequate rate of return. Anything else is speculation.” So, we must be sure that safety is virtually guaranteed along with our profit. We must make sure of this based on facts, not on opinions or what we think might happen. We must be sure of it, and it must be based on solid logic.
Buying investment property is really no different than buying stock. The market for property moves much slower than the stock market does, and this is a very good thing, for it gives us plenty of time to make informed, well calculated decisions.
If we are buying in hopes of the value going up, or relying on appreciation for profit, then we are no different than a gambler. Gamblers exist in every industry. Then, there are those who consider themselves investors because of their intense research on the qualitative factors surrounding an investment, but these people are really just speculators. Both gamblers and speculators play the guessing game, and they both try to predict the future. Most of those who “invest” really speculate, except that they think they are investing. They think that they are investing because they are doing a lot of research. However, they never look at the correct, factual information. What many of them do is simply read the opinions of “experts.”