Margin of safety (safety margin) is the difference between the intrinsic value of a stock and its market price.

Another definition: In Break even analysis (accounting), margin of safety is how much output or sales level can fall before a business reaches its breakeven point.  (FROM WIKIPEDIA)

History[edit]

Benjamin Graham and David Dodd, founders of value investing, coined the term margin of safety in their seminal 1934 book, Security Analysis. The term is also described in Graham's The Intelligent Investor. Graham said that "the margin of safety is always dependent on the price paid" (The Intelligent Investor, Benjamin Graham, HarperBusiness Essentials, 2003).

Application to investing[edit]

Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular or neglected companies with low P/E and P/B ratios. One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.

The margin of safety protects the investor from both poor decisions and downturns in the market. Because fair value is difficult to accurately compute, the margin of safety gives the investor room for investing.

A common interpretation of margin of safety is how far below intrinsic value one is paying for a stock. For high quality issues, value investors typically want to pay 90 cents for a dollar (90% of intrinsic value) while more speculative stocks should be purchased for up to a 50 percent discount to intrinsic value (pay 50 cents for a dollar).^[1]

Application to accounting[edit]

In accounting parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:

Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)

The measure is especially useful in situations where large portions of a company's sales are at risk, such as when they are tied up in a single customer contract that may be canceled.^[2]

Formula[edit]

Margin of Safety = Budgeted Sales - Breakeven Sales

To express it as a percentage, the Margin of Safety needs to be divided by Budgeted sales.^[3]

Calvin comments:

Great Sifu Benjamin Graham first coined the words "MARGIN OF SAFETY " in Investments

Using margin of safety, one should buy a stock when it is worth more than its price on the market

That means that we should only pay for a Share when Its NET NET VALUE is more than the Price We Pay.

This is different from Over Paying For Something with the Expectation that we Will Make More Money later.

SO VALUE NET NET INVESTING IS BASED ON PRESENT VALUE AS OPPOSED TO FUTURE VALUE.

Of Course Stocks With Moat  like Coca Cola, Nestle, McDonald are now selling above Net Net Value.

Where is their Margin of Safety. In this case it is their Branding & Business Model which is unassailable.

Take Milo for example. It is the no. one beverage after coffee & tea. Now there may be many brands of Tea or Coffee. BUT THERE IS ONLY ONE MILO UNDER TRADEMARK BY NESTLE. And Milo captures 90% of the market. The rest is Vico, Ovalteen & Others. 

So the MARGIN OF SAFETY DOES NOT REST ON NTA BUT ON THE ESTABLISHED CUSTOMER BASE WHICH IS ENTRENCHED IN THE TASTE BUD OF MALAYSIANS

Now For Nestle It is Now Too Expensive to Chase.

You must know that Nestle has only a Limited Geographical Market in West Malaysia, Sabah & Sarawak. Singapore has its own brand of Milo (Australia Formula without Palm Oil).

Again there is the Real Australian Brand of Milo sold in Australia which is different from Spore's Australia Formula.

So just as trees cannot growth until the Sky you can overpay for a stock.

Ok, now We Come Back To NET NET & NET NET ALONE.

Ben Graham advocates buying a Stock with at least 30% Discount to NTA

Why?

BECAUSE THIS IS THE RESERVE FOR UNEXPECTED EVENTS WHICH MIGHT CAUSE THE NORMAL FUNCTION OF BUSINESS TO SHUT DOWN FOR A TIME. A FIRE? A SUDDEN TURN OF EVENT.

THE MARGIN OF SAFETY IS TO RIDE OUT THE DANGER

Like what?

1) Like Having A Spare Tyre Well Inflated if you travel Long Journey

2) Like having a Life Jacket if you go out to Sea for fishing

3) Like Extra Cans of Petrol if you travel through places where there is no gas or petrol station

4) Like having Airbag & ABS Brake if you drive High Performance Car at Top Speed

5) Like Having Parachutes if you are up in Airplanes or Helicopters

6) Like not driving but take a taxi if you happen to get drunk (drinking is bad)

7) Like My Friend My Dr Lim the Heart Surgeon. Dr. Lim operates open heart surgery. He wears a latex glove. But Dr. Lim told me sometime after operating on the human heart he would notice that there is a small cut in the rubber glove during cleaning up.

So Dr. Lim told me as a Margin of Safety He Wears Not One, But Two Rubber Gloves Instead just as an added Margin of Safety. As HIV could infect even a Surgeon through cuts.

8) So in the Stock Market WE NEED TO INVEST WITH A MARGIN OF SAFETY.

So many failed because of this neglect.

9) Sifu Warren Buffet (the Best Disciple of Ben Graham) coined these words

Remember the First Rule Of Investment

1) NEVER TO LOSE MONEY

2) AND THE SECOND RULE IS TO REMEMBER THE FIRST RULE: NEVER TO LOSE MONEY

YES!!!

MARGIN OF SAFETY. Remember these Words & You Shall Be Safe

Warm Regards

Calvin Tan Research, Singapore

Note: Those who invest or punt loosely will in the end lose out!

Further Note From Sifu Ben's Words

One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.

Coming up next:

THE REASON WHY TA HAS DOUBLE MARGIN OF SAFETY

MARGIN OF SAFETY NO. ONE

TA OWNS TAGB (ITS VALUE EQUALS TAGB SHARES ALONE. ALL THE REST FREE>)

MARGIN OF SAFETY NO. TWO

TAGB OWNS ASSETS & INVESTMENTS

THESE COULD BE LIQUIDATED IN EMERGENCIES AS A FORM OF DEFENSE

Calvin will explain Its Intrinsic Hidden Value later

Stay tuned...