Confronted with a challenge, to distill the secret of sound investment into three words, we venture the motto, “Margin of Safety”.
Examples of Margin of Safety
- Wearing helmet while riding a bike.
- Putting on seat belts while driving car.
- Buying stocks for discount.
- Cash available in times of crisis if you have good habit of saving money.
- Multiple sources of income.
To have a true investment, there must be true Margin of Safety. And a true Margin of Safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience.
To use a homely smile, it is quite possible to decide by inspection, that a woman is old enough to vote, without knowing her age, or that a man is heavier without knowing his weight.
The Margin of Safety is always dependent on the price paid. It will be large at one price, small at some higher price, and nonexistent at still some higher price.
The Margin of Safety does not guarantee an investment against loss, it merely guarantees that probabilities are against loss, and in case of common stocks, the probabilities favor an ultimate profit.
A Margin of Safety provides protection against loss under all normal or reasonably likely conditions or variations.
Value investors, by contrast, have a primary goal, preservation of their capital.
It follows that value investors seek a Margin of Safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time.
A Margin of Safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes.
It is adherence to the concept of a Margin of Safety that best distinguishes value investors from all others.
Moral of the Story by Warren Buffett
When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And that same principle works in investing.