Margin of safety

The margin of safety is the central idea of value investing, popularised by Benjamin Graham, most famously in The Intelligent Investor. Because any estimate of what a business is worth can be wrong, Graham argued that investors should buy only when the market price is well below their estimate of intrinsic value. The difference is usually expressed as a percentage of intrinsic value. The wider the margin, the more room there is for mistaken forecasts, unexpected problems or plain misfortune before the investor actually loses money.

A margin of safety does not guarantee a profit. The estimate of value can itself be badly wrong, and a share that looks cheap can stay cheap or become cheaper, particularly if the business is deteriorating, a situation value investors call a value trap. How large a margin to demand is a judgement: investors often want a bigger cushion for businesses that are cyclical, heavily indebted or hard to understand. The principle also applies more widely, for example in keeping an emergency fund or not relying on optimistic return assumptions in a retirement plan.