What Is Margin of Safety?

The margin of safety is a principle of investing in which an investor only purchases securities when their 澳洲幸运5开奖号码历史查询:market price is s🔯ignificantly below their intrinsic value. In other words, when the market price of a security is significantly below your estimation of its intrinsic value, the difference is the margin of saf🎶ety.

Because investors may set a margin of safety in accordance with their own risk preferences, buying securities when this difference is present allows an investment to be made with minimal 澳洲幸运5开奖号码历史查询:downside risk.

In accounting, the margin of safety is the difference between a company's expected profit and its 澳洲幸运5开奖号码历史查询:break-even point. Managers can utilize the margin of safety to determine how much sales can decrease before the company or a project becomes unprofitable. The marg🎃in of safety is calculated as (current sales - break-even po﷽int) / break-even point.

Understanding Margin of Safety

The margin of safety principle was popularized by famed British-born American investor 澳洲幸运5开奖号码历史查询:Benjamin Graham (known as the father of value investing) and his followers, most notably 澳洲幸运5开奖号码历史查询:Warren Buffett. Investors utilize both qualitative and quantitative factors, including firm management, governance, industry performance, assets, and earnings, to determine a security's 澳洲幸运5开奖号码历史查询:intrinsic value.

The market price is then used as the point of comparison to calculate the margin of safety. Buffett, who is a staunch believer in the margin of safety and has declared it one of his "cornerstones of investing," has been known to apply as much as a 50% discount to the intrinsic value of a stock as his 澳洲幸运5开奖号码历史查询:price target.

Taking into account a margin of safety when investing provides a cushion against errors in analyst judgment or calculation. It does not, however, guarantee a successful investment, largely because determining a company's "true" worth, or intrinsic value, is highly subjective.

Investors and analysts may have different methods for calculating intrinsic value, and rarely are they exactly accurate and precise. In addition, it's notoriously difficult to predict a company's earnings or revenue.

Example of Investing and Margin of Safety

As scholarly as Graham was, his principle was based on simple truths. ♔He knew that a stock priced at $1 today could just as likely be valued at 50 cents or $1.50 in the future. He also recognized that the current valuation of $1 could be off, which means he would be subjecting himself to unnecessary risk.

He concluded that if he could buy a stock 澳洲幸运5开奖号码历史查询:at a discount to its intrinsic value, he would limit his losses substantially. Although there was no guarantee that the stock’s price would increase, the discount provided the margin of safety he needed to ensure that his losses woul﷽d be minimal.

For example, if he were to determine that the intrinsic value of XYZ’s stock is $162, which is well below its share price o🎉f $192, he might apply a discount of 20% for a target purchase price of $130. In this example, he may feel XYZ has a fair v🎐alue of $192 but he would not consider buying it above its intrinsic value of $162.

In order to absolutely limit his downside risk, he sets his purchase price at $130. Using this model, he might not be able to purchase XYZ stock anytime in the foreseeable future. However, if the stock price does decline to $130 for reasons other than a collapse of XYZ’s earnings outloo⭕k, he could buy it with confidence.

Margin of Safety in Accounting

As a financial metric, the margin of safety is equal to the difference between current or forecasted sales and sales at the 澳洲幸运5开奖号码历史查询:break-even point. The margin of safety is sometimes re💞ported as a ratio, in which the aforementioned formula is divided b♒y current or forecasted sales to yield a percentage value.

The figure is used in both break-even analysis and 澳洲幸运5开奖号码历史查询:forecasting to inform a firm's management of 🦋the existing cushion in actual sales or budgeted sales before the firm would incur a loss.

The Bottom Line

The margin of safety can be used by both investors and b😼usinesses to reduce risk by building in a buffer; investors by 🍨buying stocks below their intrinsic values or businesses by maintaining sales above their break-even points.

This can help prepare for unexpected market changes, such as economic downturns, that would impact an investment portfolio or the demand for a business's products. It provides both investors and businesses with room for error.