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