Benjamin Graham was one of the most famous and intellectually important investors of the 20th century. He is sometimes known as the “Father of Value Investing” for his groundbreaking research in the field of equity investing during the 1930s and 1940s. His two most famous books – Security Analysis and The Intelligent Investor – are considered classics. They are still read today by those looking for greater insight into his seminal style of investing. One of the key themes that Benjamin Graham propounded was the idea of margin of safety when investing.
Margin of safety can be defined as only buying a stock at an appropriate discount to its intrinsic value. The intrinsic value of a stock is usually characterized as its tangible book value – the value of all the real assets of the underlying company like cash, property and salable inventory minus its liabilities. This calculation explicitly excludes goodwill, patents, trademarks and other potentially valuable intangible assets that a company might own. The fundamental idea behind margin of safety investing is that the risk of future loss is greatly reduced if an investor only buys a company’s stock when it trades below intrinsic value.
This Grahamian concept of margin of safety has been a mainstay of value investors in the securities markets for decades. However, the idea can also be adapted for use in the fine antiques market as well. Many investment grade antiques are made from precious metals or gemstones, giving them an intrinsic value component. The intrinsic value of precious materials in antiques can be considered equivalent to the tangible book value of publicly traded companies.
In other words, intrinsic value effectively puts a floor underneath the market value of a fine antique in the same way that it does in a stock. As an added bonus, high intrinsic value also tends to enhance the desirability and therefore the collector’s premium applied to investment grade antiques.
Now, there are some subtle differences when applying margin of safety in stocks versus investment grade antiques. First, while uncommon, equities do occasionally trade below their intrinsic value. Antiques, in contrast, very rarely do; specimens that sell for less than their intrinsic value are quickly snapped up in the marketplace. Instead, investment grade antiques usually trade at a premium (sometimes a large premium) to their underlying intrinsic value. This premium is attributable to the artistic, historical or collector’s value of the item.
However, the fact that investment grade antiques rarely sell below their intrinsic value doesn’t invalidate the core concept of the Grahamian margin of safety. To the contrary, intrinsic value tends to create a hard floor under an antique’s purchase price. So, for example, an engine-turned, Art Deco era, sterling silver cigarette case may sell for $150, but have an intrinsic value – the bullion value of its sterling silver – of $80. This means the artistic or collector’s premium you’re paying is $70.
In this hypothetical situation, the intrinsic bullion value of our chosen objet d’art would effectively limit your potential loss to about 47% in a worst case scenario. No one intentionally buys an investment grade antique expecting it to drop in value, but in the unlikely event it does, the item’s intrinsic value prevents your loss from being excessively severe.
Now the margin of safety idea cannot be universally applied to any work of art. For example, it usually cannot be utilized with the major arts, like paintings and sculpture. Paintings are made from canvas and paints and therefore have no intrinsic value. Likewise, sculptures are usually created from stone or bronze which also have either no, or minimal intrinsic value.
When you purchase a work of major art, you’re exclusively purchasing artistic premium. This can either be very good, or very bad, depending on future price movements. In any case, you can’t rely on margin of safety to reduce risk in these situations.
Using the Grahamian concept of margin of safety to limit risk is a godsend to risk-averse investors who wish to allocate a portion of their portfolio to investment grade antiques. It allows you to boldly invest in a largely unexplored, but high-return-potential asset class while simultaneously mitigating the possibility of severe loss. Margin of safety has worked for stock investors for decades and there is no reason it can’t work for savvy antique investors as well.
