Margin Of Safety

Loading the player...

What is 'Margin Of Safety'

Margin of safety is 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.

The term was popularized by Benjamin Graham (known as "the father of value investing") and his followers, most notably Warren Buffett. Margin of safety doesn't guarantee a successful investment, but it does provide room for error in an analyst's judgment. Determining a company's "true" worth (its intrinsic value) is highly subjective. Each investor has a different way of calculating intrinsic value which may or may not be correct. Plus, it's notoriously difficult to predict a company's earnings. Margin of safety provides a cushion against errors in calculation.

BREAKING DOWN 'Margin Of Safety'

Margin of safety is a concept used in many areas of life, not just finance. For example, consider engineers building a bridge that must support 100 tons of traffic. Would the bridge be built to handle exactly 100 tons? Probably not. It would be much more prudent to build the bridge to handle, say, 130 tons, to ensure that the bridge will not collapse under a heavy load. The same can be done with securities. If you feel that a stock is worth $10, buying it at $7.50 will give you a margin of safety in case your analysis turns out to be incorrect and the stock is really only worth $9.

There is no universal standard to determine how wide the "margin" in margin of safety should be. Each investor must come up with his or her own methodology.

RELATED TERMS
  1. Value Investing

    The strategy of selecting stocks that trade for less than their ...
  2. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  3. Annual Premium Equivalent - APE

    A common sales measure technique used by insurance companies ...
  4. Intrinsic Value

    Intrinsic value is the actual value of a company or an asset ...
  5. Value Stock

    A stock that tends to trade at a lower price relative to it's ...
  6. Benjamin Graham

    A scholar and financial analyst who is widely recognized as the ...
Related Articles
  1. Stock Analysis

    The Biggest Risks of Investing in Costco Stock (COST)

    Read about some of the biggest risks of investing in Costco stock. Gain a better understanding of its business model before buying in.
  2. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  3. Fundamental Analysis

    Take On Risk With A Margin of Safety

    More common risk theories can lead to missed opportunities. Find out how margin of safety can propel your portfolio.
  4. Investing Basics

    The Intelligent Investor: Benjamin Graham

    Learn about the man who mentored Warren Buffett, who eventually became the investing "Oracle of Omaha".
  5. Active Trading

    Warren Buffett: How He Does It

    We look at the Sage of Omaha's methodology for evaluating value stocks.
  6. Forex Education

    Using The Price-To-Book Ratio To Evaluate Companies

    The P/B ratio can be an easy way to determine a company's value, but it isn't magic!
  7. Investing Basics

    The 3 Most Timeless Investment Principles

    Benjamin Graham pioneered cutting edge concepts that propelled other top investors to fame.
  8. Active Trading

    What Is Warren Buffett's Investing Style?

    Learn the main principles that Warren Buffet uses in assessing a company. His take on value investing may surprise you.
  9. Fundamental Analysis

    Value Investing: 5 Tips to Consider in 2016

    Read five tips for value investors to consider in 2016, including how to look beyond traditional metrics and when to expand outside of the value zone.
  10. Investing News

    Where Does John Templeton Keep His Money?

    Learn how John Templeton pioneered the idea of globally diversified funding where the investor hordes his money in companies located anywhere in the world.
RELATED FAQS
  1. Stocks with high P/E ratios can be overpriced. Is a stock with a lower P/E always ...

    The short answer? No. The long answer? It depends.The price-to-earnings ratio (P/E ratio) is calculated as a stock's current ... Read Answer >>
  2. How can I budget for both short-term expenses and long-term goals?

    The first step in planning for long-term goals is actually determining how much you spend on short-term expenses. Once you ... Read Answer >>
  3. What is an economic moat?

    The term economic moat, coined and popularized by Warren Buffett, refers to a business' ability to maintain competitive advantages ... Read Answer >>
  4. When does a growth stock turn into a value opportunity?

    Learn how fundamental analysts use valuation measures, such as the price-to-earnings ratio, to identify when a growth stock ... Read Answer >>
  5. Have hedge funds eroded market opportunities?

    Learn why there is still plenty of opportunity for investors even though hedge funds have grown substantially. Read about ... Read Answer >>
  6. What is the difference between passive and active asset management? (SPY)

    Find out about active asset management, passive asset management, how these strategies are utilized and the differences between ... Read Answer >>
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center