Why Margin of Safety Is Important

I read an article from oldschoolvalue.com on Why Margin of Safety Is Misunderstood And Not Used Enough where the “single most important factor in focusing on margin of safety is buying an investment at a lower price than the valuation.”  I agree with Jae Jun that most investors would link margin of safety to quality over price.  Thanks also to Jae Jun for allowing me to share his article in this post.

Margin of Safety

To understand clearly about Margin of Safety without elaborating more its definitions, Jae Jun cited some  references from great authors and value investors as follows:

Margin of safety is the difference between the intrinsic value of a stock and its market price. Another definition: In Break even analysis, margin of safety is how much output or sales level can fall before a business reaches its break even point. – Wikipedia

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. –Investopedia

A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world. – Seth Klarman

You have to have the knowledge to enable you to make a very general estimate about the value of the underlying business. But you do not cut it close. That is what Ben Graham meant by having a margin of safety. You don’t try to buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And that same principle works in investing. – Warren Buffett

In that article, it was explained clearly how one misunderstood margin of safety. It was described margin of safety in the quotes below:

1. “Quality does not ensure safety.”

2. “High quality assets can be risky, while low quality assets can be safe.”

3. “Safety of the assets or investment is all about the price you pay.  It was further explained that margin of safety is not about the business, not how shareholder friendly the management is and certainly not the growth upside.  Margin of safety is clearly all about price.”

4.  “Margin of safety investment framework starts with assessing risks and the downside before focusing on potential returns.”

Read more: http://www.oldschoolvalue.com/blog/investing-perspective/margin-of-safety-investment-framework/#ixzz3Yi1vB0eZ

Have you identified stocks in the Philippine Stock Exchange that have high margin of safety? 😉

What are those stocks. Please mention in the comments below.

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