As I mentioned in my earlier post The Best Kept Secret to Successful Investing, the most important rule to remember in investing is never lose money.
In The Intelligent Investor, Benjamin Graham introduced the concept of “margin of safety”. Buffett calls “margin of safety” the three most important words in investing. The concept is simple. But before I get to that, an understanding of the difference between price and value is crucial.
The underlying value of a company is not always reflected in the stock price. The true value of a business is what’s known as the intrinsic value. Buffett couldn’t have summarized it better, “Price is what you pay, value is what you get.”
Because no one, not even Buffett, can determine the exact intrinsic value of a business, it would be wise to allow some margin for errors in our assumptions. This margin is what Ben Graham calls margin of safety. Graham and Buffett both advocated allocating at least a 40% margin of safety.
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