Benjamin Graham, believed by many to be the father of value investing, wrote in his book The Intelligent Investor, “Confronted with [the] challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.”
Simply put, Graham’s margin of safety is the difference between a company’s stock price and its intrinsic value. Contrary to the common view that higher returns can only be achieved by taking greater risks, value investing is based upon the notion that increased returns are associated with a greater “margin of safety”, or lower risk. For investors, a margin of safety can provide some level of protection in terms of preservation of capital over their investing lifetime. In theory, the further a stock’s price is below its intrinsic value, the greater the margin of safety, and therefore the greater the stock’s resilience to market downturns AND the greater the potential upside as the stock’s price is reassessed against its intrinsic value.
“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.” Benjamin Graham