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How Big of a Margin of Safety is Sufficient?

The size of the margin of safety will vary based on investor preference and the type of investing that she or he does.
“Deep Value Investing” refers to buying stock in seriously undervalued businesses. The goal is to find significant mismatches between the current stock prices and the intrinsic value of those stocks. Due to the degree of difference, these companies are often either small, or in bad shape. If they were well known and in good shape, then there would hardly ever be a serious mismatch of value and price except possibly for major macroeconomic deterioration such as during the local market bottom of early 2009. So deep value investing requires guts. You’ve got to pick through the rubble and find value where others aren’t seeing it. You have to see information that others are not seeing, or you have to interpret and act on information that others have, but are misinterpreting or failing to act on. Needless to say, deep value investing requires a considerably large margin of safety to invest with and isn’t for most casual investors.
“Growth at a Reasonable Price (GARP) Investing” refers to a more balanced approach. With this investing method, you pick companies that have positive growth rates that are also trading somewhat below your intrinsic fair value calculation. Dividend Growth Investing falls closer to GARP investing than deep value investing, because dividend growth investing relies on selecting companies with wide moats, strong balance sheets, the ability to grow dividends through recessions, and a product or service that you can see existing and indeed flourishing 10 or 20 years from now. With GARP investing or Dividend Growth Investing, it’s important to have at least a 10% margin of safety, but it’s not very often that you’re going to find enormous differences between price and value which allows you to buy with a huge margin of safety. They’re more stable and less contrarian selections. So rather than investing with access to better information or interpretations than others, you’re merely investing with a different time horizon. While others may be fretting about a quarterly report or something Congress did or a jobs report, you’re focusing on your passive income goals a 5-10 years from now.

This article was written by Dividend Monk. If you enjoyed this article, please subscribe to my feed [RSS]