10. Margin of safety, when the story is India itself

Part 14 of 19 in The Patient Owner: Charlie Munger’s Ideas, as Rakesh Jhunjhunwala Might Have Taught Them to an Indian Investor← Part 13Part 15 →

This chapter explores how Rakesh Jhunjhunwala applies Charlie Munger's concept of margin of safety to investing in India. It addresses the importance of having multiple layers of safety when investing in a growing market like India.

Aniruddha. Ben Graham’s margin of safety, which Munger and Buffett bent from a cheap asset toward a wonderful business at a sane price. You bent it again. You were willing to pay for growth in India. Where is the safety in that? A sceptic would say you replaced a margin with a mood.

Rakesh. The sceptic is half right, and the half is how people go broke copying me. A margin of safety is a buffer against being wrong, unlucky, or lied to. It can sit in the price. It can sit in the balance sheet. It can sit in the business — a customer who would hate to leave, a cost position, a regulator who cannot easily delete you. It cannot sit only in the sentence ‘India will grow’. India will do all sorts of things. A business with no buffer plus a national story is a national story.

Aniruddha. So the India tailwind is allowed as one layer, never as the only layer.

Rakesh. One layer. Demography, formalisation, a household that is allowed to want things — these are real. They raise the odds that a good consumer business has somewhere to reinvest. They do not rescue a bad one. I have watched people buy a third-rate retailer because ‘the Indian consumer is rising’. The Indian consumer is rising. He is also not a fool. He will walk past a bad shop.

Three buffers that survive an Indian surprise

Price against a bad year, not against a dream year. If the business only works on the investor presentation’s fifth year, you do not have a margin. You have a sequence of hopes. Ask what the share is worth if growth is ordinary and the multiple is bored. If that number is not embarrassing relative to what you are paying, you may proceed to fall in love. Not before.

Balance sheet against a closed window. India closes windows: a liquidity squeeze, a sudden rule, a promoter who needs cash on a Thursday. Net cash is not always a virtue — a business that can reinvest should reinvest — but debt that assumes the window stays open is a bet on the window. Know which one you own.

Character against a surprise. This is the buffer Charlie was sternest about, and the one India most needs. You want the person who will call you when the number is bad. A margin of safety inside a dishonest culture is a spreadsheet fantasy. No price is low enough for a liar, because the liability has no floor. I did not always live up to that sentence. The sentence remains true.

Aniruddha. In surgery the margin of safety is the structure you do not cut, the blood you have in the bank, the colleague who will stop you. We do not call it conservatism. We call it finishing the list.

Rakesh. Finish the list. And do not let a bull market rename the list as timidity. The purpose of a margin is to stay alive for the day the list is what saves you. Dead investors have no compounding.

Evening question. If India grows and this company does not, do you still own a tolerable business at the price you paid? If the answer needs the country to do the company’s work, you have no margin. You have a flag.