“The Intelligent Investor “, the classic best seller by the financial guru, Benjamin Graham needs no introduction. The phrase, “margin of safety” so brilliantly coined by the financial guru in his books is the investment formula so vital to the value investing strategy. For me personally, the margin of safety formula captured the essence of the value investing strategy, the investment philosophy introduced by Benjamin Graham and perfected by the great Warren Buffet. This time tested investment strategy is considered today as the basics for fundamental investment that new investors must know before they even consider venturing into the financial market.
So, what is the phrase, Margin of Safety all about? The two salient points highlighted below will help you to have a basic understanding of the margin of safety formula.
1. The definition of margin of safety is the difference in the intrinsic value of a company as against the prevailing stock price of the company. The intrinsic value of a stock is the book value of the company, which is computed by checking the company’s total current assets less its total present liabilities. A major concept of the value investing strategy advocated by Benjamin Graham is that the greater the margin of the difference in the intrinsic value and the prevailing stock, the safer is your investment and the better the probability of a higher return for your investment.
2. According to the great guru, Benjamin Graham, there is a logical connection between the concept of safety margin and the principle of diversification. Simply explained, diversification is the companion of the margin of safety formula. While applying the safety margin formula increases the possibility of a profit than a loss for an investment in a single stock, diversification increases further the possibilities of a profit in investing in a basket of valued stocks with a high margin of safety.
Such is the authority and power of this margin of safety formula that the great Warren Buffet once advised that, when the market is in the bearish condition, investors should refresh themselves into reading Benjamin Graham’s “The Intelligent Investor”, in particular the chapter on the margin of safety. Therefore, you too should check out on this value investing strategy and applying the margin of safety formula in your quest to achieve your financial goals.