Warren Buffett, like many of his disciples, or “Buffettarians,” insist on buying the stocks that have a wide margin of safety.
When most new investors buy stocks, they automatically assume they’ll appreciate over the medium (or short) term and not crumble like a paper bag immediately after they’ve purchased shares. Otherwise, they wouldn’t have bought shares in the first place!
When the “ideal” scenario plays out, and a stock surges after an investor has bought shares, new investors immediately begin to feel like geniuses, causing them to further overestimate their abilities and underestimate their tolerance for risk.
In time, however, Mr. Market will eventually land a left hook on these investors’ chins when they least expect it. Sooner or later, investors will buy a stock that immediately begins to free-fall upon purchase, causing them to doubt their abilities and sell the stock at a loss. This isn’t investing; it’s speculating. As Buffett once said, “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes.”
Buffett’s most recent bank bets have soured right after he loaded up, but you can be sure he’s not going to be so quick to throw in the towel, and neither should you if you’re a long-term investor. Instead, you should focus on discovering businesses whose market value is lower than the intrinsic value. Such a stock that’s priced at a discount to its intrinsic value typically possesses a sizable margin of safety that can help limit investors’ downside and maximize their upside, thus greatly reducing the probability of losing money.
Of course, even the most undervalued stock has the ability to make you lose big money if you sell it at the wrong time, as the markets are a “voting machine” in the short run and a “weighing machine” in the long run, as Buffett’s mentor Benjamin Graham once put it.
How does one find a stock with a sizable margin of safety?
That’s the billion-dollar question, and, unfortunately, it’s hard to do in an efficient market.
On the bright side, as volatility continues to reign, with fear in the air on Bay and Wall Street, the degree of market efficiency falls down a few notches, opening up an opportunity for contrarians to nab stocks at huge discounts, as most other investors attempt to time their exit from the markets at the first cries of wolf.
Brookfield Renewable Partners (TSX:BEP.UN)(NYSE:BEP) stands out as a name that screams “margin of safety” now that shares are down over 17% from their highs with a massive 7.2% distribution yield — the highest it’s been in recent memory.
The renewable energy producer that has a focus on hydroelectric power-generating facilities and owns a robust portfolio of predictable, low-cost hydro projects that’ll allow for a steadily growing operating cash flow stream, allowing the company the ability to pay a generous and consistently growing distribution.
As fellow Fool Nelson Smith noted in his previous piece, the management team at Brookfield Renewable Partners isn’t willing to act on projects just for the sake of looking busy. They want an attractive return on their investment, and it’s this prudent approach that’s allowed the company to focus on the creation of value for long-term shareholders.
Management isn’t going to be swinging at every pitch that’s thrown towards them. And believe me, many baseballs are flying their way, as the world looks to accelerate its transition to sustainable energy sources.
The Foolish takeaway of Brookfield Renewables
Brookfield Renewable Partners’s 7.2% dividend yield may appear to be on shaky footing, but investors will be comforted to know that the payout is covered by free cash flow with a payout ratio of around 70%.
Given the company’s boring, low-risk approach to growth, it’ll just be a matter of time before the payout ratio falls low enough to justify another 5-9% annual distribution hike, so investors should sleep peacefully at night knowing that they won’t awaken to an unforeseen distribution reduction.
Stay hungry. Stay Foolish.
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Fool contributor Joey Frenette has no position in any of the stocks mentioned. Brookfield Renewable Partners is a recommendation of Dividend Investor Canada.