WEBVTT

00:04.930 --> 00:10.270
In this video we're going to talk about the margin of safety and how you can use it effectively to reduce

00:10.270 --> 00:14.530
risks on your investment and make a wiser investment decision.

00:14.530 --> 00:19.960
So what exactly is margin of safety margin of safety is simply the difference between the intrinsic

00:19.960 --> 00:23.110
value of a stock and its market price.

00:23.110 --> 00:26.600
For example the market price of a stock is six dollars a share.

00:26.740 --> 00:30.400
You find that its intrinsic value is about $10 a share.

00:30.400 --> 00:36.170
So in this case we have a margin of safety of $4 or 40 percent.

00:36.220 --> 00:42.450
In fact the higher the margin of safety the lower the risk on your investments the margin of safety

00:42.450 --> 00:47.700
is achieved when a stock is bought at a price which is sufficiently below underlying value to allow

00:47.700 --> 00:55.530
for human error bad luck or extreme volatility in a complex unpredictable and rapidly changing world.

00:55.540 --> 01:01.050
In other words using a margin of safety will allow you to correct your mistakes in your investment analysis

01:01.050 --> 01:05.340
and valuation Well when it comes to stock valuation.

01:05.370 --> 01:07.420
We make mistakes all the time.

01:07.570 --> 01:11.850
You know every valuation method is implemented based on assumptions.

01:11.850 --> 01:17.070
For example when using the discounted cash flow model you'll have to assume that a company's cash flow

01:17.070 --> 01:21.030
will grow at a consistent rate over the next five to 10 years.

01:21.170 --> 01:27.600
What will happen if its cash flow grows by 10 percent this year 5 percent next year and negative 8 percent

01:27.600 --> 01:28.970
in another year.

01:29.100 --> 01:34.920
You see our valuation method is somewhat biased and that's why the margin of safety concept is applied

01:35.130 --> 01:38.740
to value investing.

01:38.740 --> 01:40.860
So how much margin is acceptable.

01:41.260 --> 01:44.560
Well it depends on how much bad luck you're willing to face.

01:44.560 --> 01:48.470
Your risk tolerance and how much money you can afford to lose.

01:48.880 --> 01:51.790
Losing some money is an inevitable part of investing.

01:51.790 --> 01:57.640
In fact there's nothing you can do to prevent it but to be as sensible an intelligent investor you must

01:57.640 --> 02:02.590
take responsibility for ensuring that you never lose most or all of your money.

02:02.920 --> 02:07.630
If you think you can't afford to lose much from your stocks it always pays to have a good margin of

02:07.630 --> 02:10.770
safety say around 30 to 40 percent.

02:10.990 --> 02:16.250
This means that you must buy a $10 stock for not more than six or seven dollars.

02:16.270 --> 02:20.310
Remember the higher the margin of safety the better.

02:20.390 --> 02:25.760
And also make sure that you will always use a margin of safety about least 25 percent for the sake of

02:25.760 --> 02:26.970
your money safety.

02:28.030 --> 02:29.080
In the next module.

02:29.140 --> 02:33.730
We'll dive into some investing principles that you should always keep in mind when investing in the

02:33.730 --> 02:34.720
stock market.

02:35.520 --> 02:36.070
OK.

02:36.160 --> 02:37.270
See you in the next video.