Warren Buffett and the secret behind his successful investments



  • Margin of safety is a key principle in investing that involves purchasing a stock below its estimated fair value, thus offering protection against errors and volatility.
  • Warren Buffett emphasizes that the size of the margin of safety depends on the level of understanding of the business in which one invests; The better it is understood, the smaller the margin needs to be.
  • The formula proposed by Ben Graham to determine the margin of safety involves calculating a company’s net working capital and attempting to purchase it at one-third of that value, although this method has encountered limitations in the current market.

Warren Buffett has always emphasized the importance of applying a fundamental principle in the world of investments: the margin of safety. But what does this term really mean and how is it applied in practice?

Also read: Who is Warren Buffett and how much is his fortune?

What is the Margin of Safety?

In his own words during the 1992 annual letter to shareholders, Buffett explains: “We insist on a margin of safety in our purchase price. If we estimate that the value of a stock is only slightly higher than its price, we are not interested in buying. We believe that this margin of safety principle, so emphatically emphasized by Ben Graham, is the cornerstone of investment success.”

Simply put, the margin of safety refers to a type of cushion that protects the investor from errors and volatility when purchasing a security. This concept was detailed by Ben Graham in his 1949 book, “The Intelligent Investor ,” promoting the idea of ​​purchasing a stock below its estimated fair value, which involves calculating the intrinsic value of a security and the maximum price to pay. .

The Oracle of Omaha and the Margin of Safety Bridge

Buffett, who was a student of Graham, considered the father of value investing, at Columbia University after World War II, has used the analogy of a bridge to explain this concept. “When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000-pound trucks over it. And that same principle works in investing ,” Buffett mentioned in the 1980s.

Also read: How to Invest the Warren Buffett Way

The Margin of Safety Formula

How then to determine how low the price of a stock should be in relation to its intrinsic value to guarantee a sufficient margin of safety? Buffett recalls a simple formula learned from Graham: calculate a company’s net working capital and try to buy it at one-third of that. A company’s working capital is calculated by subtracting its current liabilities from its current assets. However, this formula has its limits in the current stock market environment.

The Importance of Understanding the Business

Buffett believes that the magnitude of the margin of safety needed comes down to how well you understand the business. “If you perfectly understood the future of a business, you would need very little in the way of margin of safety,” he said in 1997. Thus, the more volatile a business is, or potentially can be, “but assuming you still want to invest in it, the more It is the margin of safety.”

Buffett Analogies to Illustrate the Margin of Safety

The CEO and chairman of Berkshire Hathaway used another bridge analogy to illustrate this point. Driving a truck across a bridge that is rated to hold 10,000 pounds with a 9,800-pound vehicle may appear safe if the bridge is 6 inches above the crevice it covers. However, if you were over the Grand Canyon, you would want a wider margin of safety.

This prudent and calculated approach to investing has been a key factor in Buffett’s unprecedented success in the financial world. As Buffett explains, adopting the margin of safety principle not only protects the investor from costly mistakes and market volatility, but also underscores the importance of diligence and deep knowledge of the business in which one invests.

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