The three most important words for success in investing are margin of safety. A margin of safety (or safety margin) is the difference between the intrinsic value of a stock and its market price. A whole chapter on the subject, chapter 20, of Benjamin Graham’s brilliant book, The Intelligent Investor, was devoted to the subject. Many legendary investors consider this to be the greatest book ever written on value investing. “By far the best book on investing ever written” Warren Buffett.
One of his students, Warren Buffett no less, has used this technique many times during his illustrious career in investing. His company Berkshire Hathaway bought Apple shares when they were very cheap. At one stage only a few months ago Apple represented 52% of the shareholdings in Berkshire Hathaway. The price of Apple shares is now high. Berkshire Hathaway has recently reduced its holding in Apple shares by more than 50%.
Warren Buffett has explained that the share price of a typical stock in the S&P 500 Index will fluctuate in value between its highest price and its lowest price in a calendar year by 60% on average. That being the case it is always wise to wait until the share price falls during the year in order to buy the shares cheaper.
What you are ideally looking for is a situation where the share price is significantly lower than the intrinsic value of the stock. When you buy the shares at this lower price you are limiting the downside.
So what is intrinsic value?
Intrinsic value per share is an estimate of the value of a company’s stock based on its financial health and performance. It’s a theoretical concept that can be calculated using a variety of methods, including discounted cash flow (DCF) analysis or price-to-earnings (P/E) ratios.
Intrinsic value is only an estimated value but as long as it is calculated using reasonable assumptions about the share price growth rate and using a fair discount rate, it can be a valuable metric to use when assessing the true value of a company.
Wise investors know that you make money when you buy shares not when you sell them. Perverse but true. You know it makes sense.*
Tony Byrne, Managing Director
If you want to learn more about this topic, please find the link here.
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Risk warnings
Minerva Money Management Ltd (FRN: 754570) is authorised and regulated by the Financial Conduct Authority. The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.
