A good investment is all about minimising risks on investment, securing capital, and earning profit. Similarly, margin of safety is a concept in stock market investment that focuses on selecting value stocks and improving gains. The concept of margin of safety was first introduced by Benjamin Graham, father of modern investment theory.
What is margin of safety?
The definition of margin of safety, also known as MoS, is the difference between the actual sales and sales at the break-even point. In layman terms, margin of safety is a company’s income after payment of all its fixed and variable costs related to manufacturing.
What do you mean by margin of safety from an investing point of view?
In terms of investment, MoS is a principle wherein an investor purchases securities when the market value is lower than the intrinsic value. To understand margin of safety concerning the stock market, you need to identify the threshold. This is the point when MoS is at the top, and it is the best time to buy stocks.
How to calculate margin of safety?
It is expressed in terms, units, or as a percentage of total sales. The formula for margin of safety is as below:
Margin of safety = Actual sales – Sales at break-even
Another way to calculate margin of safety is to find out the difference between actual and break-even sales (units) and then to multiply the result by contribution per unit. Margin of safety can also be calculated in percentage.
Margin of safety = Profit/ Profit-Volume ratio
Margin of safety = Margin of sales/ sales x 100
Why is it important for an investor?
As an investor, it is not just enough to know whether the stock is underpriced or overpriced. You need to know the extent to which it is underpriced or overpriced. For an investor, if the market price is significantly lesser than the intrinsic value of the stock, it is a good option to invest in stocks.
Understanding MoS and being a smart investor
Experienced or novice, you as an investor might end up making an error when it comes to making valuations, forming assumptions, or deciding on the best option to invest. To avoid taking a wrong investment decision, it is prudent to make your investment journey more fruitful under professional guidance.
Reaching out to a financial advisor could help in eliminating quite some uncertainties when it comes to investing in good stocks to buy in 2021. A bespoke investment plan based on your profile and risk appetite is what you need to make smart decisions.
Explore your options with the help of an investment advisor today.