What Is Margin of Safety?
Margin of safety is a principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value. In other words, when the market price of a security is significantly below your estimation of its intrinsic value, the difference is the margin of safety. Because investors may set a margin of safety in accordance with their own risk preferences, buying securities when this difference is present allows an investment to be made with minimal downside risk.
Alternatively, in accounting, the margin of safety, or safety margin, refers to the difference between actual sales and break-even sales. Managers can utilize the margin of safety to know how much sales can decrease before the company or a project becomes unprofitable.
KEY TAKEAWAYS
- A margin of safety is a built-in cushion allowing for some losses to be incurred without major negative effect,
- In investing, margin of safety incorporates quantitative and qualitative considerations to determine a price target and a safety margin that discounts that target.
- By purchasing stocks at prices well below their target, this discounted price builds in a margin of safety in case estimates were incorrect or biased.
- In accounting the safety margin is built into break-even forecasts to allow for some leeway in those estimates.