Margin of Safety: Find Out with ETMarkets: What is Margin of Safety?

Safety margin – these three words form the crux of invest.

Once you understand what margin of safety means and how to use it while investing, you can make better investment decisions in your life.

This article will introduce you to the basics, the importance and how you can benefit from margin of safety.

What is margin of safety?
Benjamin Graham, the father of modern investing, introduced the term.

Investors always want to buy stocks at a price lower than the price they are trading at now. However, when stocks plunge due to uncertain situations, they are often scared to buy and speculate on what will happen next.

But, when there is uncertainty and the market plunges significantly, that’s when the stock is available at sale price!

Take the COVID-19 market drop as an example. It was one of the worst falls ever imagined. This market fear keeps most investors from investing.

However, the COVID-19 market slump is a stock market open for sale, bringing golden opportunities for investors. All it takes is confidence to invest.

But how do you have enough confidence to invest at such times?

Well, this is where the margin of safety comes into the picture.

The margin of safety is nothing but the principle of buying a stock when its share price is significantly below its intrinsic value. This is a strategy that helps you invest at the right time and ensures that the range of losses is low.

If you carefully analyze the market of Mr.

Here you need to learn the art of understanding the value of business.

How to understand the intrinsic value of a stock?
A variety of factors can determine a stock’s intrinsic value. It is a combination of financial as well as non-financial factors.

Financial factors include operating margin, PE ratio, dividend yield, sales growth, and profit growth.

Non-financial factors include the quality of the company’s management, economic situation, competitors in terms of products, assets and goodwill.

All of these factors form the intrinsic value of the stock.

What does Benjamin Graham say about margin of safety?
Graham explains the concept of margin of safety with an example:

Assume the price of a stock is $1. It may happen that the actual value of the same stock may be close to $0.50. So if you buy it for $1 today, you’re adding unnecessary risk.

If you buy the stock for 50 cents instead, your chances of losing money are significantly reduced compared to buying it for $1 when you bought it at a 50% discount.

You can earn higher returns by buying undervalued stocks that will eventually realize their true potential over time.

This is why, when you know the true value of the stock and the market is falling, you can still buy the stock with confidence.

Why is the margin of safety important?
When you buy undervalued stocks, you are protecting yourself from unnecessary losses, along with the possibility that the stock price could rise again when the market eventually moves up.

Therefore, by implementing a margin of safety strategy, you keep the risk while the chances of making a profit are high.

Last Notes
A higher margin of safety below the intrinsic value of the stock protects you from losses. Focusing on the margin of safety encourages you to be a patient investor and buy stocks at the right price.

(Author is Founder, TejiMandi)

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