Margin of Safety, Explained

When contemplating an investment, I might get excited about a company and want to immediately snap up shares of its stock. But I’ve learned that I should try to determine the value of the company and a fair price for the company’s stock before buying. As a general rule, I don’t want to pay more for a company than it is worth.

Going further with this idea, I may decide to invest only if I can pay less than the company’s value. If I adopt this philosophy, I buy shares of a company only when its price represents a bargain or discount from its value. That is, I incorporate a margin of safety into my investing decisions.

This idea of a “margin of safety” has been articulated and popularized by value investing thought leaders Benjamin Graham, the author of The Intelligent Investor, and Warren Buffett, Graham disciple and billionaire investor.

The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, and nonexistent at some still higher price.” — Benjamin Graham, The Intelligent Investor

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