When it comes to managing risk, one of the most valuable lessons I’ve learned is Benjamin Graham’s principle of the “margin of safety.” Simply put, this principle means buying an investment at a price significantly below its intrinsic value, creating a buffer that can help cushion against unexpected downturns. Warren Buffett, who studied under Graham, applies this principle consistently in his own investing, and it’s a strategy that has deeply influenced how I approach managing client portfolios. Let me share why this approach is so effective and how it’s played out in my experience.
The beauty of a margin of safety is that it’s essentially a built-in insurance policy. By buying assets at a discount, we allow room for market fluctuations without jeopardizing the investment’s core value. For example, let’s say a company’s stock is trading at $80, but a careful analysis reveals an intrinsic value closer to $120. If we can buy that stock at $80, we’re giving ourselves a margin for any miscalculations or unforeseen events. Essentially, we’ve created a 33% cushion, which allows for a downturn without a complete loss.
Years ago, I was assessing a company in the manufacturing sector that was struggling through a temporary industry downturn. After a deep dive into its financials and business model, it was clear that the company’s core operations and long-term prospects remained strong despite its current undervaluation in the market. At the time, the stock was trading at a steep discount, about 40% below what I calculated as its intrinsic value. By taking advantage of this margin of safety, we had the security of knowing that even if the stock price dipped further in the short term, our initial valuation left room to ride out market fluctuations. In the end, the industry recovered, and the stock price surged, allowing us to exit the position with substantial gains. This experience reinforced how powerful the margin of safety can be.
A recent example of this concept can be seen with the energy sector. In 2020, during the height of the pandemic, energy stocks were heavily discounted due to a plunge in oil demand. While the sector faced a temporary crisis, companies with solid fundamentals—like ExxonMobil—were trading at significant discounts. Investors who assessed Exxon’s long-term intrinsic value and recognized the opportunity to buy it with a substantial margin of safety were rewarded when oil prices rebounded, and Exxon’s stock surged. What made this a sound investment was the margin of safety that allowed investors to weather the short-term volatility without sacrificing the investment’s core value.
One of the main reasons I advocate for this principle with my clients is because it inherently reduces risk. Markets are unpredictable, and even with the best analysis, external factors—like economic changes, industry shifts, or geopolitical events—can affect stock prices. A margin of safety provides that essential cushion, protecting investments from volatility and unforeseen changes in the market. And in times of market correction, those investments bought with a margin of safety are more likely to recover and gain ground.
For those who may be new to this concept, the margin of safety does require patience and discipline. It’s about waiting for the right opportunity to buy assets at a favorable price rather than diving in at market highs. But this patience often pays off. In fact, one client I worked with initially found this approach a bit frustrating. He was eager to buy into a tech company that had been making headlines, but its price was far above what I’d calculated as its intrinsic value. I encouraged him to wait, and eventually, market volatility brought the price down. By waiting to buy at a discount, he not only minimized his risk but also positioned himself for greater returns once the company’s stock recovered.
In today’s volatile market, understanding and applying the margin of safety is more important than ever. This principle allows us to take advantage of mispricings without betting everything on unpredictable market movements. It has proven time and again to be a valuable safeguard, both for individual investors and for large portfolios. By focusing on buying below intrinsic value, we’re building in a protective layer that can reduce the downside risk.
The margin of safety isn’t about playing it safe in the conventional sense; it’s about being strategic. It’s about recognizing that while we can’t control market outcomes, we can control the level of risk we’re willing to take. And by buying with a margin of safety, we give ourselves the best chance to grow wealth sustainably, with a solid buffer against the unexpected. For any investor, Graham’s principle remains as relevant as ever—perhaps even more so in a world where risk and reward are inextricably linked.