✅ Lesson 6: Margin of Safety — How to Protect Yourself When Investing

You’ve mastered understanding the business (Mastery)…
You’ve checked its competitive advantages (Moat)…
You’ve verified the numbers (Metrics)…

Now comes the fourth M: Margin of Safety — the key to protecting your investment from mistakes, bad luck, or unexpected changes.

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✔️ What Is Margin of Safety?

Margin of Safety means buying a great company at a price well below its true value.

Definition:
A cushion between the price you pay and the business’s true worth, to protect yourself from risk.

Why it Matters:

Even great businesses can hit rough patches, face market downturns, or make bad decisions. Buying with a margin of safety gives you room for error — and still a good return.

Warren Buffett learned this idea from Benjamin Graham, who taught:

“The essence of investment management is the management of risk, not the management of returns.”

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🔢 How to Think About Margin of Safety

1. Estimate the company’s fair value.
2. Decide how much discount you need to feel comfortable (usually 15–35%, based on how conservative your assumptions are).
3. Only buy if the market price is below your target.

Example:
If you think a stock is worth $100 per share:
A 25% margin of safety means you want to buy it at $75 or less.
If it’s $100 or higher — you wait.

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📊 How I Estimate Fair Value — A Quick Look at My DCF Approach

There are many ways to value a business, but I use the Discounted Cash Flow (DCF) method because it focuses on the most important thing: how much cash the business can generate.

That’s what a DCF does:

It takes current earnings and projects them into the future to get the expected cash flows over 20 years, then discounts them back to today — adjusting for inflation, risk, and time.

A few details on my approach (no need to do the math — I’ve done it for you):

• I assume the company only lasts for 20 years — no guessing with terminal values.
• I estimate growth over the first 10 years in 5-year increments.
• For the last 10 years, I apply a rate around 4–4.5% — based on GDP growth + inflation.
• I use both:
  • WACC (Weighted Average Cost of Capital)
  • CAPM (Capital Asset Pricing Model)
    These consider the company’s beta, long-term inflation expectations, and a risk premium.
• I always lean conservative: slower growth, thinner margins, and higher costs.

💬 Tip:
If a stock still looks cheap under conservative assumptions — you likely have a real margin of safety.

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🧠 Key Principle: Price Matters

Even the best company can be a bad investment if you overpay.
And sometimes, an average company, if bought cheap enough, can deliver great returns.

Buffett says it simply:

“Price is what you pay. Value is what you get.”

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💡 Summary: Margin of Safety

• It’s your protection against mistakes.
• Always estimate value conservatively.
• Only buy when the price gives you enough cushion.
• Patience is your edge — wait for the right setup.

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🔑 Key Takeaway for Today

A good company at a bad price is still a bad investment.
A good company at a great price — that’s how fortunes are built.