From Wikipedia, the free encyclopedia

Margin of safety (safety margin) is the difference between the intrinsic value of a stock and its market price.

Another definition: In Break even analysis (accounting), margin of safety is how much output or sales level can fall before a business reaches its breakeven point.

Benjamin Graham and David Dodd, founders of value investing, coined the term margin of safety in their seminal 1934 book, Security Analysis. The term is also described in Graham's The Intelligent Investor. Graham said that "the margin of safety is always dependent on the price paid" (The Intelligent Investor, Benjamin Graham, HarperBusiness Essentials, 2003).

Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular or neglected companies with low P/E and P/B ratios. One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.

The margin of safety protects the investor from both poor decisions and downturns in the market. Because fair value is difficult to accurately compute, the margin of safety gives the investor room for error.

A common interpretation of margin of safety is how far below intrinsic value one is paying for a stock. For high quality issues, value investors typically want to pay 90 cents for a dollar (90% of intrinsic value) while more speculative stocks should be purchased for up to a 50 percent discount to intrinsic value (pay 50 cents for a dollar). This can be seen with Warren Buffett's pick of JNJ in 2007. He thinks he is getting at least a 10% discount for this high quality stock. In 2007, his pick of Petro China was at his thought that it was trading 80% below intrinsic value. After he sold the company, he said in interview his initial thought was that its intrinsic value (market cap) was close to $100 Billion when it was valued at $20 Billion.

In investing parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:

Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven Sales Level (quantity or dollar amount)

Also, Margin of Safety is a rare and out-of-print book written by Seth Klarman, founder of Baupost Limited Partners, a value investing group based in Boston, MA. Copies of his book are considered something of a collector's item and it can regularly be found on eBay for more than $700.

• Graham, Benjamin. Dodd, David. Security Analysis: The Classic 1934 Edition. McGraw-Hill. 1996. ISBN 0-07-024496-0.
• http://www.businessweek.com/magazine/content/06_32/b3996085.htm