 |
Benjamin
Graham had emphasised on margin of safety
while making investing decisions. All legendary value investors, including
Warren Buffett, Charles Munger, Walter Schloss not only vouch for margin of safety but harp on it.
Why
is it so important?
The
reason is simple.
History
shows that managements of companies, even the best managed ones, often make
huge mistakes, harming not only the company’s prospects but seriously impairing
the value of investors’ interests.
Besides
management mistakes there are many environmental risks – political turmoil, disruptive
technologies, etcetera.
When
you buy the shares below the intrinsic value, when such a management mistake
happens you may exit the investment without a loss or a minimum loss. Whereas
the person who had bought the share at a very high premium to the intrinsic
value naturally suffers a huge loss.
 |
| Investor taking the high risk way |
Let
us consider the following example:
Value Investor
|
High Risk Investor
|
||
Intrinsic value of the share
|
240
|
||
Price at
|
192
|
434
|
|
Price after a serious disastrous event
|
200
|
||
Profit/ (Loss)
|
8
|
-234
|
In
investing the golden rule is do not incur
a loss.
When
one buys a share below its intrinsic value, the gap provides the margin of safety. The price difference of Rs.40
provided a 16.67% margin of safety to the value investor, which helped to exit
the investment at a low profit of Rs.8 whereas our high risk taking investor
had to suffer a huge loss of Rs.23k!
