Turbulence and Margin of Safety

Met up with Guoyi last night and had Claypot Crab Bee Hon at Don. He’s really one of the most unique individual I know. He got the damn what the world thinks attitude which is so so rare. He gave me some insights to what Chemical Engineering is about; and my general impression is that the aim of the course is to create and design processes and equipment to mass produce experimental results.

He also gave me a refresher course on turbulence and on the significance of Reynolds number. Above a certain Reynolds number (~2400) , the flow is defined as turbulent flow. And I read on Wikipedia that (i) “Within a certain range around this point there is a region of gradual transition where the flow is neither fully laminar nor fully turbulent, and predictions of fluid behaviour can be difficult”, such that (ii) “many engineers will avoid any pipe configuration that falls within the range of Reynolds numbers from about 2000 to 3000 to ensure that the flow is either laminar or turbulent.”

Guoyi also mentioned that to many engineers, they think in terms of 10^n, ie 101 and 999 belongs in the same ‘family’. The rationale is that if you are designing processes or apparatus, it better be able to hand sufficient strain on the system to prevent catastrophe. For instance, Jun Bin told me that for the mask that is worn by fencer, it can ‘tahan’ way higher newtons of force than what normally happens during fencing.

All these examples reminds me once again on the Margin of Safety principle as expounded in “The Intelligent Investor” and practised by generations of value investor to great success. The idea is simple, only buy a security (stocks, bonds, etc) if the price is SIGNIFICANTLY LOWER than the value of the security.

“It is quite possible to decide by inspection, that a woman is old enough to vote without knowing her age, and that a man is heavier that he should be without knowing his exact weight.”
Security Analysis – Benjamin Graham


The advantages of MoS are twofold:

1) The buffer helps protect our capital.

Firstly, the value we place on the security is never exactly precise, so if you think the stock is worth $100, the ‘real’ value could be between $90 – $110. So it would be silly to buy at $95, cuz you could very well be overpaying. However, if you could buy the same thing for $70, then the $30 buffer would act as your safety net. This is exactly the same principle as applied by engineers during their design phase.

2) Margin of Safety boosts your return.
Assuming that you are right on the assessment of the value of the business at $100.
And you managed to purchase the stock at $70, with a MoS of $30.
Furthermore, the underlying business grow at 10% per annum.
And in 5 years time other investors recognise the merit of the company and bid the stock to a level that is correspondent to the business value, ie 100 x 1.10^5 = 161.

Your total return would be whopping 18% return. Way above the 10% return you would get by only assessing the value of business right and buying it at fair value.

With such brilliance and insights, its no wonder Guoyi is often flanked by girls in the school (from empirical evidences gathered by my very biased JC classmates in NUS library).