When to Buy Any Stock: Consider Margin of Safety

Having computed intrinsic value of a stock, we know that a stock should be purchased only if the market price is below the stock's intrinsic value.

"How MUCH lower should the price be relative to the intrinsic value?"

Think of the margin of safety for any stock as the difference between a stock's intrinsic value and its market price.

If you buy a stock at its intrinsic value, you will have no margin of safety.  

• If everything goes as you assume in your calculations, you will earn an annual rate of return equivalent to the discount rate assumed.
• For example, if you assume a discount rate of 7 percent and purchase the stock at intrinsic value, your annual rate of return will be 7 percent.  

If the same stock is purchased at 25 percent below the intrinsic value, 

• the calculations show that the rate of return will be about 10 percent per year.  

And if the stock is at half the intrinsic value, 

• the rate of return will be about 15 percent.  

So it seems logical that you should buy a stock with a large margin of safety.

An alternate way of thinking about looking for a large margin of safety is to require a large discount rate.

Related posts:

Intelligent Investor Chapter 20: Margin of Safety as the Central Concept of Investment

The Intelligent Investor: “Margin of Safety” as the Central Concept of Investment

Value Investing: Provide a Margin of Safety

Everything Buffett Needs to Know, He Learned Right Here

****Price to Earnings Growth Ratio (PEG) Explanation

A great company can be a lousy investment. Always incorporate a margin of safety.

Buying when the price is right.