Margin of Safety

Is your buy price below the intrinsic value?

Margin Of Safety (MOS) can be defined as a principle of investing when the market price is significantly below the estimation of the intrinsic value. This difference allows an investment to be made with minimal downside risk. The term was popularized by Benjamin Graham (known as “the father of value investing”) and his followers, most notably Warren Buffett. 

Interpretation of the definition itself explains that MOS is always a secondary step for investing. It comes only when you are ready with your intrinsic worth.  If the Value investor named above says that “according to me stock market doesn’t exist”, “my preferred holding period is forever” and “that stock price is the least important information an investor should look at”, by no interpretation they are talking about the downward risk of share price while speaking MOS. We believe they are referring to a margin of safety against going wrong on their judgment on intrinsic value.

Determining a company’s “true” worth (its intrinsic value) is highly subjective. MOS doesn’t guarantee a successful investment, but it does provide room for error in an analyst’s judgment. MOS provides a cushion against errors in calculation and downturns in the market.

Recently an acquaintance bought shares of a Housing Finance company- DHFL. The reason behind it, he said, “it’s simple, the share price has come down from `650 to `55 in less than a year, abhi kitna tutega (how much it will fall further)??” He believed that he is having a good margin of safety.  A common mis-interpretation of a margin of safety is how far stock may fall further if one is paying for a stock. However, as discussed above it is the difference between the intrinsic value and market value of the stock.

“Stock prices are random but the value is not”.

– Warren Buffet