margin of safety

Margin Of Safety

A principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. In other words, when market price is significantly below your estimation of the intrinsic value, the difference is the margin of safety. This difference allows an investment to be made with minimal downside risk.

The term was popularized by Benjamin Graham, who is widely considered the father of value investing, as well as his followers, most notably Warren Buffett. Margin of safety doesn't guarantee a successful investment (nothing does), but it does provide room for error in an analyst's judgment. Remember that what a company is "really" worth (its intrinsic value) is highly subjective. Each investor has a different way of calculating intrinsic value which may or may not be correct. Plus, it's notoriously difficult to predict a company's earnings. Margin of safety provides a cushion against these errors in calculation.

Investopedia Commentary

Margin of safety is a concept used in many areas of life, not just finance. For example, consider engineers building a bridge that must support 100 tonnes of traffic. Would the bridge be built to handle exactly 100 tonnes? Probably not. It would be much more prudent to build the bridge to handle, say, 130 tonnes, in order to ensure that the bridge will not collapse under an extremely heavy load. The same can be done with securities. If you feel that a stock is worth $10, buying it at $7.50 will give you a margin of safety in case your analysis turns out to be incorrect and the stock is really only worth $9.

How wide should the "margin" in margin of safety be? Unfortunately, there is no easy answer, and each investor must come up with his or her own methodology.

Related Links

Value By The Book
Warren Buffett: How He Does It

See also: Benjamin Graham, Intrinsic Value, Valuation, Value Investing, Value Stock, Warren Buffett

Also spelled: marginofsafety, margin-of-safety

Main Entry: therapeutic index
Function: noun
: a measure of the relative desirability of a drug for the attaining of a particular medical end that is usually expressed asthe ratio of the largest dose producing no toxic symptoms to the smallest dose routinely producing cures

margin of safety n.
The amount between a therapeutic dose and a lethal dose of a drug.