What Is Margin of Safety?
Margin of safety means buying a stock well below what you think it is worth. The gap protects you if your estimate is wrong or bad luck strikes.
Where the idea comes from
Benjamin Graham, the teacher of Warren Buffett, made it the core of value investing. An engineer builds a bridge to hold far more weight than it will ever carry. An investor should buy with room for error too.
A simple example
You estimate a company's intrinsic value at $100 a share. Buying at $70 gives you a 30% margin of safety. Even if you were too hopeful and it is worth only $85, you still did not overpay.
How much is enough?
There is no fixed rule. Riskier, harder-to-predict companies deserve a bigger margin. Steady, simple businesses need less.
Related terms
Intrinsic valueWhat a business is really worth.
Value investingBuying good companies for less than they are worth.
Undervalued vs overvaluedWhen the price is below or above the real value.
Discounted cash flowValuing a company from its future cash.
Risk toleranceHow much ups and downs you can handle.
P/E ratioHow many years of profit you pay for in a share.