The difference between the market's price and our estimate of value is the margin of safety.
The goal of any investor should be to buy stocks for less than they're really worth.
Unfortunately, it is easy for estimates of stock's value to be too optimistic - the future has a nasty way of turning out worse than expected. We can compensate for this all-too-human tendency by buying stocks only when they're trading for substantially less than our estimate of what they're worth (margin of safety).
For example:
There is no question that Coke had a solid competitive position in the late 1990s, and we can make a strong argument that it still does. But those who paid 50x earnings for Coke's shares have had a tough time seeing a decent return on their investment because they ignored a critical part of the stock-picking process: having a margin of safety.
Not only was Coke's stock expensive, but even if you thought Coke was worth 50x earnings, it didn't make sense to pay full price - after all, the assumptions that led you to think Coke was worth such a high price might have been too optimistic. Better to have incorporated a margin of safety by paying, for example, only 40x earnings in case things went awry.
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