Warren Buffett is the master of value investing. This is a trading philosophy he obtained from his professor and the author of the book “The intelligent Trader.” Benjamin Graham wrote this book at a time Warren Buffett was looking for resources to read on the topic of investing. This was the book that changed the life of Warren Buffett. One of the principles taught by Benjamin Graham is “margin of safety.” The principle is right at the core of the value investing strategy.
Margin Safety according to Graham is a simple to understand the concept that facilitates proper and wisdom based investment. One of the things he includes in this principle is the importance of checking the history of the company before investing. A company should have generated enough capital to meet its bills and interest payment in a year.
The ability of a firm to earn more than the interest requirements is what Graham defined as the margin of safety. The margin of safety is supposed to protect the investor from losses in a case where the company faces a decline in its income In the future.
Just like it happens with banks, they will not lend you if they believe you can just afford to pay the interest and nothing else. Ability to have more funds to cushion against a decline in the borrower’s income is needed. This is the same principle Graham is demanding in assets and stock investments.
Warren Buffett is a good student of Graham model of value investing took this matter and made sure that he practiced it. Warren Buffett compares the margin of safety to building a bridge. An engineer will build a bridge to handle 30,000 tons while they know that only 10,000 tons vehicles will pass on the bridge. The allowance created is the margin of safety. It should never be too close to the actual value.