1/ 🧵 What is Margin of Safety?
The margin of safety is an investment principle where you buy securities only when their market price is significantly below their intrinsic value. This difference acts as a cushion, minimising downside risk. 📉🛡️
2/ Key Takeaways:
- Built-in cushion to handle some losses without major damage.
- Combines quantitative and qualitative assessments to set a price target and safety margin.
- Buying stocks below target price builds safety in case of wrong estimates.
- In accounting, the safety margin helps determine how much sales can drop before unprofitability.
3/ Investment Genius:
The concept was popularised by Benjamin Graham and Warren Buffett. They look at factors like management, industry performance, assets, and earnings to determine intrinsic value. Buffett often applies a 50% discount to this value as his price target! 🧠💼
4/ Accounting Perspective:
In accounting, the margin of safety is the difference between current or forecasted sales and break-even sales. It informs managers of the cushion before incurring losses. It can also be reported as a ratio to show the percentage of buffer sales.
5/ Calculating Margin of Safety:
Determine break-even sales and budgeted sales. Subtract break-even from actual or forecasted sales, then divide by sales. The result is a percentage showing how far sales can drop before hitting break-even. 📊✏️
6/ Margin of Safety in Dollars:
It’s simply current sales minus break-even sales. This helps you understand the dollar amount of safe sales. 💵
7/ Margin of Safety vs. Operating Leverage:
While margin of safety is the difference between actual and break-even sales, the degree of operating leverage shows how operating income changes after a percentage change in sales. They serve different purposes but are both crucial financial metrics. 📉🔄
Conclusion:
Using the margin of safety effectively ensures you invest with minimal risk. It acts as a buffer against mistakes and market volatility, making it a powerful tool for smart investors. Remember, it’s all about buying with confidence and staying safe! 🚀🛡️
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