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Margin Of Safety Investing

Margin Of Safety Investing by Investor Vantage

“If you were to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.”

– Benjamin Graham

When it comes to investing in the stock market few people can give you better advice than Warren Buffett. Back in 1971 Mr. Buffett gave a first-hand demonstration of the three key investment principles that everyone should keep in mind when making investment decisions. We will discuss this in a minute with his purchase of Washington Post…

He explained that to be successful at investing you had to first change the way you thought about stocks; rather than looking at the numbers going up or down, instead you need to think of them as representing a partial ownership in a business. And you you needed to let the market serve you, not guide you. But for the new investor, probably the most important thing they need to understand is how to determine a stock’s ‘margin of safety.’ Once they have grasped this concept they will be better equipped to make investment decisions with a lower level of risk.

What Is Margin of Safety?

According to the father of value investing, Benjamin Graham, the term “Margin of Safety” refers to an investment principle “in which an investor only purchases securities when the market price is significantly below its intrinsic value.” This means that if a stock is valued at $10.00 per share, for example, but is trading at $6.00 per share, the difference between the two prices would be considered the margin of safety. In short, the further a stock’s price dips below its intrinsic value, the greater your margin of safety will be.

The trick is properly calculating a business’s intrinsic value.

“Proper accounting is like engineering. You need a margin of safety. Thank God we don’t design bridges and airplanes the way we do accounting.”

– Charlie Munger

Determining the Intrinsic Value of a Stock

The basis for discovering a stock’s “margin of safety” hinges on being able to ascertain the business’s estimated intrinsic value. We use the term here ‘estimated’ because it is literally impossible for anyone (including the most astute and experienced investors in the market) to be able to determine the exact intrinsic value of a business. This is because the intrinsic value is generally based on assumptions; the investor can only be expected to make an educated guess in this regard. This means that learning how to determine the margin of safety is of extreme importance when evaluating the investment opportunities before you. Your margin of safety will give you a certain amount of protection and allow room for error in light of the many fluctuations that could occur under the current market conditions.

So, how do we determine intrinsic value?

Investment gurus suggest that you look at stocks that hold plenty of tangibles (cash, property, inventory, etc.) rather than focus on those things that are hard to measure. Intellectual property, for example, may be of a certain value but it may be difficult to measure in plain old dollars and cents. By always buying your stocks when...