Margin of Safety

The term margin of safety was coined by the founders of value investing, Benjamin Graham and David Dodd in their book Security Analysis. It is one of most essential investing principle which is whole heatedly followed by the Oracle of Omaha, Warren Buffet.

Margin of safety means to buy a stock well below its intrinsic value. For instance, the current market price(CMP) of stock ABC is $100 whereas your analysis tell you that the intrinsic value is $200. The difference between the intrinsic value and CMP. Intrinsic value is not easily to calculate. Additionally, it varies from people to people. It is the perception of the investor of the inherent assets of the company. For you the intrinsic value of the company may be $100 billion whereas for me it may be of $49 billion.

Warren is known to have applied 50% discount on the intrinsic value of stock as its target price.

Margin of safety is also an accounting concept, where we calculate the difference between the actual sales and the break even sales. Break even sales, the tipping point at which the company makes neither profit nor loss. By knowing the margin of safety, one knows how much actual sales need to drop for a company to reach the break even.