Margin of Safety

Margin of Safety 

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 MARGIN OF SAFETY

The word 'Margin of Safety' itself having a huge weight. But most of the new comers or market beginners as well as many of old market participants are unaware of this powerful term. 

The concept of 'Margin of Safety' was first introduced by the Sir Benjamin Graham (We know them as the Father of Value Investing) & He is the mentor of Mr. Warren Buffet.

Sir Benjamin Graham explained the concept of 'Margin of Safety' for normal public by example of weight carrying capacity of bridge. Suppose we have pass a truck of 1000 tons over a bridge then, we have to build a bridge with a carrying capacity of 1200 tons. This excess 200 tons is the 'Margin of Safety' for bridge to pass over the truck with a weight of 1000 tons.

Ok we will see the 'Margin of Safety' in technical term later on which is used in stock market, but in our day to day real life also we use this concept in many ways like 1. Reserve petrol concept in petrol tank in our vehicle is the extra 'Margin of Safety' to fill up petrol before it completely finished anywhere in unknown place. 2. The use of credit card is also one type of concept of 'Margin of Safety', whenever our cash is over still, we can pay money in case of emergency. In this way there are many more example in our life which we can relate with 'Margin of Safety'. So, intelligent calculated people use this concept very well in both personal and professional life. 

So, lets talk about the concept of 'Margin of Safety' in technical way.

 

What is the concept of Margin of Safety?

Margin of safety is an investing idea that states that an investor should only buy shares if their market price is much lower than their true worth. In other words, the margin of safety is the gap between the market price of a stock (stock market price should have to be less than actual value) and your estimate of its actual value. Because investors can define a margin of safety based on their risk choices, buying shares when this gap exists allows for a low-risk investment. 

By purchasing equities at a discount to their target price, a 'Margin of Safety' is built in case estimates are wrong or inaccurate. 

Example of Investing with 'Margin of Safety' 

If we estimates that our stock ABC has an intrinsic value of $150, and CMP of our stock ABC is $180. So our estimated intrinsic value is well below its current share price of $180. 

Now we will apply a 20% discounting on our estimated intrinsic value of $150 then our purchase price will be  $120. 

In this case, we believe stock ABC is presently valued at $180 is ok, but we might not buy it for more than our estimated intrinsic value of $150. 

For more safety we sets our buy price at $120 with a discounting of 20%  on our estimate intrinsic value in order to completely eliminate our downside risk. 

According to the model of 'Margin of Safety', we may not be able to purchase stock ABC in the coming years. But we may buy it with confidence, if the stock price come down to $120 for any reasons other than a downturn in stock ABC's earning outlook.

Conclusion

Its time to wrap up. So, 'Margin of Safety' is very strong concept beneficial for the long term investor. Who wants to buy a share on rare occasion when shares are available at their discounted rates. 

To become a successful  investor in stock market, we need to learn and imply practically this concept of 'Margin of Safety'.

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