How to Calculate a Margin of Safety

Value investing

Margin of safety is an investing term used by value investors. It was made popular by the father of value investing, Benjamin Graham, whose famous students include Warren Buffet. The margin of safety is the difference between the intrinsic value of the investment and the market value of the investment. The challenge is in determining the intrinsic value of a market-based asset.

Instructions

1. Look up the current price and the earnings per share of the stock you would like to find the margin of safety on. You can usually find these numbers on the Investor Relations section of the website or on your favorite investment research site.

2. Divide the price by the earnings per share for the P/E ratio. This is a commonly used valuation multiple which helps investors to determine whether or not a stock is over- or under-valued.

3. Subtract the P/E multiple for the company from the average P/E multiple for the industry. You can find industry P/E ratios on your favorite investment research site as well. Two popular sites are Yahoo! Finance and Google Finance. A positive/negative number means the stock is under-/over-valued and the amount of the difference tells you by how much.

4. Multiply the difference by the earnings per share of the company for the dollar amount of the difference. For instance, if the difference between the company P/E and the industry P/E is 3 and the earnings per share for the company is 2, then margin of safety is $6.

References

• Investopedia: Margin of Safety