Margin of Safety
Buying at a price well below the value you calculated, so that losses stay smaller even if your judgment is wrong — a core principle of value investing.
Margin of safety = the gap (cushion) between the estimated fair value and the actual purchase price
The further the price sits below the estimated fair value, the larger the margin of safety, leaving room to hold up even if the judgment turns out wrong.
In plain terms
When a bridge is designed, it's built to hold far more weight than it will actually carry, so it won't collapse even if the estimates are off. The margin of safety works the same way. If you see a stock's value as $10, you buy it at around $6 rather than $10.
That way, even if your value estimate was somewhat off or an unexpected setback arrives, the loss isn't large. It's not "buy when it's cheap" but "buy at a price sufficiently below the value, allowing for the chance that you're wrong."
What it tells you
The margin of safety starts from admitting "I could be wrong." No matter how much you analyze, the future is unknown, so you cover that uncertainty with room in the price.
Benjamin Graham, the father of value investing, emphasized it, and his student Warren Buffett named it one of the most important concepts in investing.
Formula
Margin of safety = the gap (cushion) between the estimated fair value and the actual purchase price Example: if you see a stock as worth $10 and buy it at $6, the margin of safety is $4
What high or low means
The further the price sits below the estimated fair value, the larger the margin of safety, leaving room to hold up even if the judgment turns out wrong. When the price is close to or above the value, there is almost no margin of safety, so even small bad news leads to losses.
That said, "the price looks low" is not the same as a margin of safety. If the value calculation itself is wrong, the margin of safety is an illusion too (so the margin of safety depends on how conservative the value calculation was).
The trap of the margin of safety is that "there is no guarantee the value I assigned is correct." If you believed the price was below value but that value estimate was wrong, the margin of safety was never there to begin with. So the more generously you set the value, the thinner the margin of safety becomes.
Using the margin of safety as an excuse to buy "as long as it's low" is also risky. There may be a reason the share price level is low (a value trap), so price alone does not create a margin of safety.
The "margin of safety" is a concept Benjamin Graham, the father of value investing, emphasized in his 1949 book "The Intelligent Investor." His student Warren Buffett later named "margin of safety" as the three most important words in investing.
The margin of safety is a way of building "I could be wrong" into the price in advance. Since even the best analysis cannot perfectly predict the future, you buy at a price sufficiently below the calculated value and cover the room for error with price.
Metrics to read alongside
See it in real stocks
Search US stocks on Stocklore to see SEC-filing-based financial metrics alongside the sector benchmark.
This explanation is for information and reference only and is not a recommendation to buy or sell any security. Investment decisions and their consequences are your own.