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Stocks 405: The Fat-Pitch Strategy

Introduction to The Fat-Pitch Strategy The Fat-Pitch Strategy: Look for Wide-Moat Companies The Fat-Pitch Strategy: Always Have a Margin of Safety The Fat-Pitch Strategy: Don't Be Afraid to Hold Cash The Fat-Pitch Strategy: Don't Be Afraid to Hold Relatively Few Stocks The Fat-Pitch Strategy: Don't Trade Very Often Summary of The Fat-Pitch Strategy
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The Fat-Pitch Strategy: Always Have a Margin of Safety

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The Fat-Pitch Strategy: Always Have a Margin of Safety

Instead of buying a stock based on what everyone else is doing, you might buy a stock only when it's selling at a decent margin of safety to your estimate of its fair value. Don't even think about the overall direction of the stock market, because that's impossible to predict with any consistency. By doing this, you'll need to exercise a lot of discipline and wrestle with the fear of missing out on a market rally. Patience is indeed a virtue when using this approach because oftentimes it may take many months or longer before a fat-pitch opportunity presents itself.

Things To Know

  • Rest assured that there will be opportunities in the future.
  • Fat-pitch investing has two built-in factors that help offset the risk that your fair value estimate is wrong.

Don't give up hope

Although you may feel at times that the market is running away from you and a fat pitch may never come around, rest assured that there will be opportunities in the future, and you'll be poised to swing away. Think only about individual wide-moat companies; if you find one where the price is irrationally low relative to its long-term intrinsic value, consider buying it. If not, hold off for a fatter pitch.

Do some math first

Obviously, to determine whether a particular stock is trading with a sufficient margin of safety, you must have some sort of an estimate of what you think the stock is worth. Sufficient study of investing will have given you enough information that you should start to be able to place a value on a stock. We encourage you to practice this repeatedly to hone your valuation skills.

Also, you must determine how much of a margin of safety you'll require before buying a stock. If the firm is not very risky, you could be content with a 15–20% discount to its fair value. If the firm is riskier than average, you may demand a 30–40% discount. Ultimately, it's your decision.

How you can protect yourself

The beauty of fat-pitch investing is that it has two built-in factors that help offset the risk that your fair value estimate is wrong. First, by requiring a margin of safety, you've given yourself some "error cushion," just in case your estimate was too high. Second, by purchasing wide-moat companies, chances are high that the firm will increase in value over time. Thus, even if your estimates were way off, the firm—and its stock price—will likely appreciate in value, eventually catching up to your fair value estimate. In effect, by buying wide-moat companies, you have another margin of safety built into your investment.