In our view, the best way to reduce risk and achieve long-term gains is not to attempt to predict the short-term moves of the stock market and jump in front of them, but rather to buy great companies run by astute business people at a discount to their intrinsic value.
An important part of our investing approach is the concept of margin of safety. The intrinsic value of a company is typically a function of its future earning power or asset value, and since the future is inherently uncertain and difficult to predict, you must accept that you will make mistakes in your assumptions. Thus, in order to protect principal, you can only invest in securities if they sell at a significant discount to your estimate of their intrinsic value (providing that margin of safety). An added benefit of investing with a large margin of safety is the potential return if the future works out as forecast.
In times when securities are cheap compared to their intrinsic value, you will see us invest heavily, while when the gap closes, you will see us retreat into cash if we are unable to find opportunities that meet our criteria. This is very different from most professional investors who are primarily focused on “career risk” and thus tend to stay fully invested (and follow the crowd), often in the most expensive securities.