Margin of safety
The margin of safety is the gap between the value a valuation assigns to a company and the price it trades at. Buying with a margin of safety means paying below the estimated value, so that an error in the assumptions does not automatically turn into a loss. It is the explicit acknowledgement that every valuation is an estimate, not a measurement.
How it is calculated
| Estimated value per share | €100 | |
|---|---|---|
| Market price | €70 | |
| Margin of safety, (100 − 70) ÷ 100 | 30 % |
Margin of safety = (estimated value − market price) ÷ estimated value. If your valuation gives €100 per share and the market offers it at €70, the margin is 30 %. It is not a return target: it is how wrong you can be about the valuation before you lose money. With 30 %, your estimate can turn out to be 30 % optimistic and you will still have bought at fair value. The more uncertain the business, the more margin is worth demanding, because what you are covering is not the market but your own error.
The figures in the example are invented and rounded so the arithmetic can be redone by hand. They are not data from any real company.
What it is not
It is not a stop-loss and it does not protect you from the share falling: it can fall another 40 % with the margin intact, because the margin is measured against your valuation and not against your purchase price. It is not a guarantee either: if the valuation is wrong, the margin you compute on top of it is wrong too. And it is not the same as «buying cheap»: a low P/E gives you no margin of safety if you have not valued the business.
See the full glossary · What the Celsmar financial terminal is
Definition for informational purposes. It is not financial advice nor a recommendation to buy or sell.