Margin of Safety – The Key to Value Investing

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.

Why is margin of safety so important ?

i. Being wrong is part of the investing process. Intrinsic value estimate calculated by a person would be different from the value calculated by another. Errors may creep in the calculations. So, it’s more like an insurance policy that helps prevent us from overpaying—it mitigates the damage caused by over-optimistic estimates.

ii. Any estimates, at best, are imprecise; at worst, they are completely wrong. Let’s assume that your intrinsic value calculations were 100% right. Still, what about future uncertainties? The future is uncertain. It’s a fact. You need to provide a margin for this uncertainty you face. Nobody is an exception to this. All the analysts and experts in this world make mistakes and they face uncertainty. Hence margin of safety is important.