Margin of safety

The gap between what you pay and the value you believe an asset has - deliberate room for the estimate to be wrong.

Example

Buying at 9,000,000 against a central estimate of 11,000,000 leaves 18.2% of room before the purchase price exceeds the estimate.

Important

It protects against the errors you did not anticipate, which is the only kind that matter. A margin calculated by lowering your estimate until the current price looks safe is not a margin.

Related terms

• Valuation — An estimate of what an asset is worth, as distinct from the price it currently trades at. Built from what the asset produces plus judgements about growth, duration and required return.
• Intrinsic value — What an asset is worth on the basis of what it will produce for its owner, independent of what anyone is currently willing to pay for it.
• Liquidation value — What the assets would realise if the business stopped operating and everything were sold, after settling what is owed.

Lessons that explain it

• When to walk away, after you have already spent — By the time walking away is the right answer, you have usually spent money, months and a quantity of public commitment - and all three argue in the same wrong direction. (12 min)
• Appraising one company: the figures, and the growth already in the price — A practical pass over one listed business - what it earns, what it owes, what cash it keeps, and what the current price is already assuming. (14 min)
• Why valuation is a range, and never a number — Every valuation method takes uncertain inputs and multiplies them together, so the output is a band rather than a figure. The habit worth building is refusing to collapse it. (9 min)
• What each method is for, and what to do when they disagree — Three methods on one asset produce three different answers, and the disagreement is the most useful output. Averaging it away destroys the only thing the exercise produced. (10 min)
• Work backwards: what would have to be true to justify this price? — Rather than producing your own valuation and comparing it with the price, take the price as given and solve for the growth or margins it assumes. Then judge whether those assumptions are plausible. (11 min)

All 578 terms in the Investing glossary