What is a margin of safety?
A margin of safety is the gap between what you pay for a stock and what you think it is worth. Buying well below your estimate leaves room for mistakes and bad luck.
A simple example
Say you estimate a company is worth 100 dollars a share. If you buy at 70 dollars, your margin of safety is 30 percent. If your estimate turns out a bit too high, you may still not lose money.
Why it matters
Nobody can predict the future exactly. Sales can slow, costs can rise, and your own math can be wrong. A margin of safety is a cushion for all the things you cannot know.
Where the idea comes from
Benjamin Graham called it the central idea of investing in The Intelligent Investor. Investor Seth Klarman later used Margin of Safety as the title of his own book.
Limits
The margin is only as good as your estimate of value. If you misjudge the business, a stock that looks 30 percent cheap may not be cheap at all. A low price alone is not a margin of safety.
Frequently asked questions
How big should a margin of safety be?
There is no fixed rule. Investors often want a bigger cushion for businesses that are harder to predict and a smaller one for very steady businesses.
Can I see a fund's margin of safety in its 13F?
No. A 13F shows what a fund owns, not what it thinks each stock is worth. Some managers explain their thinking in their letters.