What is: Margin of Safety – Understand It With Stock Examples

Invest in companies with moat and margin of safety, and the probability of your investment paying off, in the long run, is very high.

So what is “margin of safety”?

The margin of safety in investment in coined by Warren Buffet and so let us understand with a quote from him.

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety.

The definition can vary from investor to investor. Some consider the amount of cash in the companies book as the margin of safety whereas others consider growth and better business environment as “margin of safety”. For some great management is the margin of safety.

Being in the market for almost a decade, I am still learning to move from being a trader to an investor. I have a tough time not to look at price movement of my investments in each of my stocks. The plan is to look at the performance of the companies from quarter to quarter and view the results of the company without worrying too much about the price. Still, I can’t achieve it and I admit I check the price of the stocks on a daily basis. Yes, you read it right. I want to be doing things once every quarter but I do it daily.

The reason I do it daily is I trade based on chart patterns and has always treated price as the ultimate indicator. As an investor, I only need to worry about the business more than the price.

As I follow the quarterly results of the company and go through the annual reports, I find it less intriguing to check the price movement of my investments. The knowledge I gain about the company, management, and the business provides me with the margin of safety and I can stop checking the price.

So my view about the margin of safety is, how much you know about the company, the people who run the company and the business.

Let me share examples of recent blunders I have done to my open portfolio to understand margin of safety with real examples.

I exited from Ashok Leyland and the main reason for my exit was – I did not have the margin of safety with respect to the company or the management though I had good insight into the business. I assumed the chart pattern formed in Nifty will lead to correction led by auto sector. The decision to exit was completely non-business related and it has proved to be a great learning experience for me.

Other position in my portfolio like Pidilite or Zydus Wellness where even when I was in the losses, wasn’t worried because I understood the business, the company and the management much better. More margin of safety.

What is your view about “margin of safety“? Share them in comments below.