What is margin of safety?
In one line: Margin of safety is the gap between what you estimate an investment is worth and the price you pay, kept as a buffer in case you're wrong.
A simple example
Say you study a company and estimate each share is worth about $50. The stock trades at $35.
- Gap: $50 − $35 = $15.
- Margin of safety: $15 ÷ $50 × 100 = 30%.
If the stock traded at $48, the margin would be only 4%. Very little room for error.
Your $50 is an estimate, not a fact. That's the whole point. The buffer is there because your estimate could be too high.
Where it comes from
Benjamin Graham made it famous in The Intelligent Investor, first published in 1949. He called margin of safety the central idea of investing. Warren Buffett, his best-known student, has praised the idea for decades.
Our summary of The Intelligent Investor covers the rest of the book.
Why it matters
Every estimate of value rests on guesses about future sales, costs and rates. Some guesses will be wrong. A big margin of safety means you can be quite wrong and still not have overpaid.
It's the same idea traders use with risk. We size every trade so that being wrong costs a small, set amount. The position size calculator does that math. Investors build the buffer into the price. Traders build it into the stop and the size.
A common mistake
Thinking a stock that has fallen a lot must have a margin of safety. A price drop alone doesn't create one. If the business got worse, its true value may have fallen even more than the price. The buffer only exists against a careful estimate of value, using things like Book value and free cash flow.
Write your value estimate and your reasons down before you look at the price. It's harder to fool yourself that way.
Questions
What is a good margin of safety?
There's no fixed number. Graham-style investors often look for a large gap, and want more for businesses that are harder to value.
Who came up with margin of safety?
Benjamin Graham, in his books Security Analysis (with David Dodd, 1934) and The Intelligent Investor (1949).
Does margin of safety guarantee I won't lose money?
No. It lowers the chance of overpaying, but your estimate can be wrong and prices can fall further.
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