What is the Margin of safety ?

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Hello boys, here we go with another lesson. Hope you enjoy and gain some added knowledge. Today’s topic is the margin of safety.

Margin of safety is a principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value. In layman’s terms when the market price of a security is significantly below your estimation of its intrinsic value, the difference is the margin of safety. This buffer allows you to invest with minimal downside risk because the lower purchase price offers some protection. Investors set a margin of safety according to their own risk preferences, allowing them to buy securities, with confidence that they are getting a good deal and reducing the likelihood of significant losses.

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The margin of safety principle was popularized by famed British-born American investor Benjamin Graham (known as the father of value investing) and his followers, most notably Warren Buffett. Buffett, often sets his price target for a stock at up to 50% below its intrinsic value. He considers this a key principle of investing. Both absolute royalty in the investing game. So if it’s good enough for them, your ass should definitely know about it too.

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QUICK EXAMPLE OF IT IN ACTION ✅

For example, if Buffett determines the intrinsic value of ABC's stock is $100, but its current price is $120,

He might set a target purchase price of $75, applying a 25% discount.

Although he believes the stock is worth $120, he won't buy it above its intrinsic value of $100. To further limit his risk, he sets his buying price at $75.

This means he might not buy ABC stock anytime soon, but if the price drops to $75 without a decline in the company's earnings outlook, he would buy it confidently.

Do this evaluation with a few companies and eventually you will see some reward.

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Word of the wise

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Some certain small things to think about when using this technique.

A margin of safety in investing provides a buffer against mistakes in judgment or calculation. However, it doesn't guarantee a successful investment. Figuring out a company's "true" worth, or intrinsic value, is highly subjective. Different investors and analysts (dummies who aren’t subscribed to our newsletter and printers club) use various methods to calculate intrinsic value, and they are rarely completely accurate. Moreover, predicting a company's earnings or revenue is notoriously challenging.

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So like most of the lessons I give you, use it as a tool, don’t think it’s a slam dunk and bet the house and wife on it every time ( unless you want her gone 😅)

Cheers.

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