How Margin of Safety Works?
In the investing world, investors have to bear different types of risks such as market fluctuations, mischance, imprecision and incorrect valuation. This could result in investing in wrong stock which thereby can cause loss. Hence all seasoned investors prefer margin of safety in their investment.
Margin of safety is the concept where the investment is done in the stock which is available at discounted price than its intrinsic value. Higher the discount, greater will be the margin of safety and vice versa. This acts like insurance to the portfolio against any uncertain risk, bad luck or human error as it already reduced the extent due to entry at discounted price.
The best way to explain the margin of safety is by Warren Buffet’s ‘Bridge Analogy’. It states that whenever the bridge is built, engineers always consider the factor of safety. That means even if he is aware that only 10 tonne trucks will be passing through that bridge, it is constructed to bear the load of a 30 tonne truck. This is what margin of safety is all about.
“The three most important words in investing… Margin Of Safety”
Deep Value Investing
We follow a deep value investing principle in order to have a better margin of safety. We think that it is better to buy a quality business at discount than at full price. Hence we look for the companies which are priced at significantly less than its fair price. This ensures that the portfolio is protected from the valuation risks and market volatility.
High Growth Stocks
We identify the stocks which have a high competitive advantage and possess high growth rate but are undervalued. This may be the case as the market may fail to recognise their value and hence the stocks are either consolidating or are not performing. We invest in such stocks and reap the benefits to maximum when their value unfolds over the period of time.
Diversification
We build a better margin of safety by diversifying the portfolio by investing in companies which are not closely correlated. Having different companies and industries in our portfolio provides a good buffer to the portfolio and protects it from the market tides. Also, it helps us to find more investment opportunities that can fulfil our safety requirements.
Capital Protection
Our main objective is to build wealth without any compromise on safety of capital. Having a higher margin of safety in our investments help us to keep our objective intact. We let go an attractive business trading at extreme valuation if it does not offer any margin of safety. By this way we get the desired cushion against the uncertainty and get better risk-adjusted returns.
The Brighter Mind Approach
We, at Brighter Mind, firmly believe that capital safety is the most important part of investing than generating the returns. As a great investor Warren Buffet says-“Rule No.1 Never lose money and Rule No. 2 is never forget Rule No. 1”.
In order to protect the capital of the investors, investing in stocks with better margin of safety is important. Equity market is full of uncertainty and no one can predict what may happen in future. Hence when we enter any stock with higher margin of safety, it gives us cushion against such market volatility and risk factors which are generally out of our control.
By using the margin of safety concept and by avoiding buying quality stocks which are expensive, we manage to minimise the chances of loss. Also, it helps us generate superior returns on our investments as the stocks we bought were available at much undervalued price.
