What is Margin of Safety
Margin of safety is an investing principle that involves only procuring a security when its market price is substantially less than its intrinsic value.
Margin of safety is a principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value. In other words, when the market price of a security is significantly below your estimation of its intrinsic value, the difference is the margin of safety. Because investors may set a margin of safety in accordance with their own risk preferences, buying securities when this difference is present allows an investment to be made with minimal downside risk.
In accounting, the margin of safety, or safety margin, refers to the difference between actual sales and break-even sales. Managers can utilize the margin of safety to know how much sales can decrease before the company or a project becomes unprofitable.
Margin of Safety
BREAKING DOWN Margin of Safety
The margin of safety principle was popularized by famed British-born American investor Benjamin Graham (known as the father of value investing) and his followers, most notably Warren Buffett.
Investors utilize both qualitative and quantitative factors, including firm management, governance, industry performance, assets and earnings, to determine a security's intrinsic value. The market price is then used as the point of comparison to calculate the margin of safety. Buffett, who is a staunch believer in the margin of safety and has declared it one of his 'cornerstones of investing,' has been known to apply as much as a 50% discount to the intrinsic value of a stock as his price target.
Taking into account a margin of safety when investing provides a cushion against errors in analyst judgment or calculation. It does not, however, guarantee a successful investment, largely because determining a company's 'true' worth, or intrinsic value, is highly subjective. Investors and analysts may have a different method for calculating intrinsic value, and rarely are they exactly accurate and precise. In addition, it's notoriously difficult to predict a company's earnings or revenue.
Explaining the Reasoning Behind the Margin of Safety
As scholarly as Graham was, his principle was based on simple truths. He knew that a stock priced at $1 today could just as likely be valued at 50 cents or $1.50 in the future. He also recognized that the current valuation of $1 could be off, which means he would be subjecting himself to unnecessary risk. He concluded that if he could buy a stock at a discount to its intrinsic value, he would limit his losses substantially. Although there was no guarantee that the stock’s price would increase, the discount provided the margin of safety he needed to ensure that his losses would be minimal.
For example, if he were to determine that the intrinsic value of XYZ’s stock is $162, which is well below its share price of $192, he might apply a discount of 20% for a target purchase price of $130. In this example, he may feel XYZ has a fair value at $192 but he would not consider buying it above its intrinsic value of $162. In order to absolutely limit his downside risk, he sets his purchase price at $130. Using this model, he might not be able to purchase XYZ stock anytime in the foreseeable future. However, if the stock price does decline to $130 for reasons other than a collapse of XYZ’s earnings outlook, he could buy it with confidence.
Margin of Safety in Accounting
As a financial metric, the margin of safety is equal to the difference between current or forecasted sales and sales at the break-even point. The margin of safety is sometimes reported as a ratio, in which the aforementioned formula is divided by current or forecasted sales to yield a percentage value. The figure is used in both break-even analysis and forecasting to inform a firm's management of the existing cushion in actual sales or budgeted sales before the firm would incur a loss.
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Investors are all too often lured by the prospect of instant millions and fall prey to the many fads of Wall Street. The myriad approaches they adopt offer little or no real prospect for long-term success and invariably run the risk of considerable economic loss - they resemble speculation or outright gambling, not a coherent investment program. But value investing - the s...more
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Published October 1st 1991 by HarperCollins
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Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
0887305105 (ISBN13: 9780887305108)
English
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Top 5 Quotes / Thoughts:
1. Page 5: “You don’t understand. these are not eating sardines, they are trading sardines” [Difference between investment (buying stream of cashflows) and speculation (return solely dependent on re-sale).]
2. Page 81: “Buffet’s first and second rules of investing: 1) don’t lose money; and 2) never forget the first rule” [Don’t expose yourself to appreciable loss of principal. Make sure that your downside is bounded (Taleb).]
a. Compound interest is the 8th wonder of the w...more
Anyone interested in taking a hands-on approach to their portfolios would benefit from Klarman's guidance in Margin of Safety. The author likens Wall Street to a casino full of speculators with odds stacked in their favor, and against the individual investor that tries to compete on uneven ground. The opening line is a quote by Mark Twain: 'There are two times in a man's life when he should not speculate--when he can't afford to and when he can.' Klarman implores the reader to implement and foll...more
I read this book after reading 'Fooled by Randomness', and that had left me wondering whether trading/investing is really purely random or can there really be method to the madness. Much to my delight, Seth Klarman does provide a sound method to achieve investment success that is based on business fundamentals than pernicious speculation, relying on the 'wisdom' of the market. The book is a fascinating read, especially for someone with a non-finance background but fresh out of a B-School, where...more
Although I wouldn't spend $1000 for this book, he surprised me by summing up in a few simple sentences...
- how the mortgage tranched CDOs are flawed,
- how the rating agencies are claiming it was unforseeable, and
- how it could all blow up by a credit crunch.
But the most amazing part was that he did this in 1991 (when the book was published) and that is way before the mortgage CDOs were in full swing.
I just wish I had read the book earlier.
Brady Bunte
I had high hopes for this book since the ratings were amazing. However, I gave this book 2 stars because many of the ideas and concepts that were mentioned were already known to me. I also found this book more difficult to read than other investment books, perhaps due to the writing style.
Margin of Safety is a famous phrase coined by Ben Graham half a century ago, and taken up by Seth Klarman here as a full volume. Unfortunately, this book is no longer in print, but I managed to score a copy without having to pay the $500 price advertised on amazon.com.
The book is in three parts. First, a strong case for fundamental value investing as the only sound framework for making investment decisions; second is a scathing critique of 'institutional investing,' culminating with Klarman's ri...more
Oct 12, 2010Steve Bradshaw rated it it was amazing
An excellent book written by an highly credible figure in the value investing world. I didn't always agree with the author. For example, I do think a long consistent track record of paying meaningful dividends is worth considering along with more direct value factors like P/E and P/B and I prefer the Graham/Lynch approach of diversifying into 20-30 stocks (versus focusing on 10 mega-picks) which I consider prudent and worth the slight reduction in potential return. However, I was extremely impre...more
Dec 03, 2014Sukhesh Miryala rated it really liked it
Great outline about how to think about investing, and less about specific strategies to invest. Provides great lenses to look at investing followed by illlustrative anecdotes. Some of the actual advice is a bit dated (but to be expected given the age of the book). This book is a must read if you are interested in learning about how value investors (of which Seth Klarman is a legend) think.
The original value investor Benjamin Graham's current equivalent is this guy: Seth Klarman. Some may think that Warren Buffet is applyinh Graham's principles, but more than anyone Klarman really mirrors Graham's thinking.* Like Graham, Klarman grew up Jewish on the East Coast. Both did well in school and had plenty of opportunities in academia but decided to take to money management instead. Like Graham, Klarman's greatest claim to fame was this book he published: Margin of Safety- Risk Averse S...more
Sep 10, 2018Tomas Krakauskas rated it really liked it
A lot of wisdom from personal S.Klarman experience, illustrated with real examples. However I find this book more suitable for novice investors who seek basic knowledge on value investing principles
Geeking it out in the rain. Re-reading a book I bought randomly at The Strand and read in 1996 when I first started in the business. I guess there was only one printing in 1991, and now it's impossible to find and goes for over $1000 for a decent copy on Amazon or Ebay. Hmmm.... Is actually a great primer on how to think like a smart professional investor. Concepts aren't hard, but I don't imagine it would be all that interesting for the individual investor.
Excellent. It was a far superior read the the intelligent investor as it 1) included all of the same ideas + some additional ones 2) wasn't sooo old, so the language was much clearer and easier to follow; 3) wasn't riddled with examples from the 60's(i.e. wasn't written from the perspective of being a 'current' guide to the markets; 4) was significantly shorter/more concise.
Jun 04, 2014Arseny rated it it was amazing
Woke up regarding the meaning of Value. Very impactful book. Most important finding is that the value is outside S&P500, and probably at the top of the bottom-performers of the day, week, month.
If I'd paid the going rate for a used, poor condition copy of over $1000, I would be disappointed. The book has some good information, albeit much of it out of date. I disagreed with a lot of his notions around speculation and think Buffet communicates these sentiments much more reasonably and convincingly.
I find the book a little bit disorganized, I have summarized a few points below:
1. There is one crucial difference between investment and speculation:
Investments throw off cash flow for the benefit of the owners; speculations do not. They return to the owners of speculations depends exclusively on the vagaries of the resale market.
and this coincides with Buffett's view as well, as he once said:
So there’s two types of assets to buy. One is where the asset itself delivers a return to you, such as...more
Nov 10, 2015Daniel Olshansky rated it it was amazing
Another great read for any Buffet 'disciples' who are interested in value investing and security analysis.
Other than graham's own books, it's difficult to say that it was a quintessential read, but it packed a lot provided how short it was. Reiterating concepts of fundamental analysis including key ratios and discount cash flow, this book delivered the basics of value investing in a very concise manner. Aside from reviewing basic principles, and hearing the opinion of another experienced investo...more
This book is a comprehensive guide to value investing - an investing approach defined by Ben Graham and followed by most successful investors and hedge fund managers. It covers many topics from the mechanics of financial industry and markets, value investing process and tools, to advice for choosing brokers or money managers. It provides many examples of value opportunities and it covers business valuation too, although very briefly - so don't except much (or any) numbers crunching.
Book covers a...more
This book is divided into 3 parts comprising 1. How market works, 2. How to invest and 3. Searching for investments. First part is an eye opener for any wanna be investor to learn how wall street works and why prices deviate from their intrinsic value. Second part focuses on basics of investing, delving into highly important valuation techniques. This is crux of the book and is worth reading many times. Third part focuses on how to search for investments, its good but is less relevant for Indian...more
Margin Of Safety Ebook
Apr 04, 2013John rated it really liked it
Priceless book (even if Amazon disagrees). The book is broken up into principles of investing we all know, yet rarely follow when methods are actually put to practice. How is Klarman different from all the other finance writers? Instead of beating the proverbial dead horse of investing dogmas , this book explains how we all come up short because of Wall Street's house edge and our bias towards the latest investing fad. Given this context, the age old investing lessons we all choose to ignore for...more
Jan 10, 2015Dude-von Dudenstein rated it liked it
Margin Of Safety Book Pdf Download
Good introduction to value investing. The author dwells too much on what's wrong with other valuation methods without talking about how should an investor go about executing value investing. Pros of value investing are too less compared to cons of investing time analysing the underlying businesses. Book is not really targeted towards an audience and seems to wander between individual investor and institutional one. Recommended read but the content delivery is lacking coherence..
It's hard to convey how important this book is to someone who is not on the buy-side of the investment management industry. He logically articulates all the structural, behavioral, and logical errors that institutional investors commonly commit. In terms of his value investment philosophy, it is no wonder his returns have been so strong. He is simply willing to go places where other investors do not, which tilts the odds of performance in his favor.
Seth Klarman's Margin of Safety is a terrific primer on the difference between investment and speculation. Originally published in 1991 but now long out of print and famously hard to find, Margin of Safety highlights many of the key tenets of value investing, most of which remain completely philosophically relevant even two decades later.
Nov 30, 2011Brentley Campbell rated it it was amazing
I loved Margin of Safety! Seth Klarman does a great job of explaining different ways to be a value investor all the way from how to research to trading. He uses examples that he found through his work at Baupost to illustrate his points and shows many special situations that can be taken advantage of. A must read for any investor.
Very comprehensive overview of value-investing from an institutional/professional standpoint which had good, informative case studies of risk-arbitrage deals.
Not from the corner of value investing but it was a very enjoyable read - although slightly underwhelming considering how much this book has been overhyped ;)
This book is outdated but the wisdom is timeless. Value investing takes discipline, patience, and a will to go against the grain. But, over time, it is the best investing strategy. You will never look at Wall Street and the 'herd' the same.
** the book is out of print but I highly recommend hunting down a copy from a library.
Very good book, totally worth a read if you can grab a copy.
I think S. Klarman writes extremely well and makes you grasp things easily.
Particularly appreciated the discussion of the flaws of EBITDA: Klarman discusses why it leads to 'chronic overvaluation of businesses' (his words) & uses clear exemples.
You probably won't find a hard copy as it is out of print and selling 2000 USD per copy. Seth Klarman is well known for keeping substantial amount of cash (>50%) in his portfolio when the he cannot find attractive opportunity. Nonetheless, excellent book which discuss the essence of Value investment: Margin of safety.
great contrarian way to think about investing from one of the great value investors. some of the commentary is a bit dated and I disagree w him on his assessment of index investing but good for the professional as well as amateur investor
Finally read what many consider one of the two seminal books (the other being the Intelligent Investor) for value investors. Nothing overly new/groundbreaking here, but overall a very well written book, with some great real world (albeit dated at this point) examples.
Jan 26, 2012Christopher Benassi rated it it was amazing
Great, structured approach to value investing. Just a notch behind Graham in terms of how his views were comprehensively expressed and lays out a solid foundation for further investigation into the realm of investing
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Seth Klarman is an American hedge-fund manager and a billionaire who founded the Baupost Group, a Boston-based private investment partnership, and the author of a book on value investing titled Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. Klarman is a graduate of Cornell University and Harvard Business School where he was a Baker Scholar.
Klarman grew up in...more