Friday, 20 January 2012

Margin of Safety Concept in Undervalued or Bargain Securities

The margin-of-safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. 
  • We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. 
  • That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse than average luck. 
  • The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. 
  • For in most such cases he has no real enthusiasm about the company’s prospects.

True, if the prospects are definitely bad the investor will prefer to avoid the security no matter how low the price. 

But the field of undervalued issues is drawn from the many concerns—perhaps a majority of the total—for which the future appears neither distinctly promising nor distinctly unpromising. 
  • If these are bought on a bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results. 
  • The margin of safety will then have served its proper purpose.

Ref:  The Intelligent Investors by Benjamin Graham

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