3 Answers: Margin of Safety? In Value Investing what is the safety margin theory?


I have read a lot about value investing and this idea of a margin of safety comes up a lot. Can someone tell me more about what it is exactly and maybe even some information about how to work out a margin of safety which is… err… safe?

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Timmy 4 years 3 Answers 1044 views 0

Answers ( 3 )

  1. OK so let’s talk about talk the margin of safety and how you can use it effectively to reduce risks on your investment and make a wiser investment decision. That is your question, correct?

    So what exactly is margin of safety margin of safety is simply the difference between the intrinsic value of a stock and its market price.

    For example the market price of a stock is six dollars a share.

    You find that its intrinsic value is about $10 a share.

    So in this case we have a margin of safety of $4 or 40 percent.

    In fact the higher the margin of safety the lower the risk on your investments the margin of safety is achieved when a stock is bought at a price which is sufficiently below underlying value to allow for human error bad luck or extreme volatility in a complex unpredictable and rapidly changing world.

    In other words using a margin of safety will allow you to correct your mistakes in your investment analysis and valuation Well when it comes to stock valuation.

    We make mistakes all the time.

    You know every valuation method is implemented based on assumptions.

    For example when using the discounted cash flow model you’ll have to assume that a company’s cash flow will grow at a consistent rate over the next five to 10 years.

    What will happen if its cash flow grows by 10 percent this year 5 percent next year and negative 8 percent in another year.

    You see our valuation method is somewhat biased and that’s why the margin of safety concept is applied to value investing.

    So how much margin is acceptable.

    Well it depends on how much bad luck you’re willing to face.

    Your risk tolerance and how much money you can afford to lose.

    Losing some money is an inevitable part of investing.

    In fact there’s nothing you can do to prevent it but to be as sensible an intelligent investor you must take responsibility for ensuring that you never lose most or all of your money.

    If you think you can’t afford to lose much from your stocks it always pays to have a good margin of safety say around 30 to 40 percent.

    This means that you must buy a $10 stock for not more than six or seven dollars.

    Remember the higher the margin of safety the better.

    And also make sure that you will always use a margin of safety about least 25 percent for the sake of your money safety.

    In the next module.

    We’ll dive into some investing principles that you should always keep in mind when investing in the stock market.

    Hope this answers your question Timmy, feel free to message me for more info!


  2. Hey Timmy. If you want to become a successful value investor avoiding losses should be your first priority even over generating investment gains.

    Remember rule number one never lose money.

    And rule number two never lose money.

    And I can tell you rule number three and number four again never lose money.

    Here’s an interesting fact.

    It’s simple math.

    If your portfolio’s value drops by 20 percent and then grows by 20 percent you’ve lost money.

    More to the point.

    In that situation you need larger returns to meet your goals over time that might lead you to take larger risks than you should which could lead to more losses as a value investor.

    You can minimize the risk of big losses by investing at a discount to a company’s intrinsic value and that’s why you need to use the margin of safety as a part of your valuation process.

    While you may not always get market beating growth but if you can minimize losses and the need to recover from those losses you’ll need less growth to meet your investing goals over time.

    And besides giving yourself a high margin of safety there are many ways you can go about minimizing losses on your investments for example you can easily avoid common costly mistakes like over trading by only investing in companies that you’re sure that you’ll make a profit with.

    And before making any trade you should always have an entry and exit strategy in mind.

    And don’t forget to place a stop loss to protect your money.


    Remember Warren Buffett’s first and second rule of Value Investing..

    Never lose money.

  3. The Margin of Safety… you should read Seth Klarman dude

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