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A central idea in classic value investing: buy only when there's a meaningful gap between price and estimated value — a cushion against being wrong about the estimate itself.
No fair-value model, including a DCF, is perfectly accurate — it rests on assumptions that can turn out wrong. 'Margin of safety' says: don't buy just because the price is slightly below the estimated value — buy only when the gap is large enough that even if the estimate is off by a reasonable amount, you're still left with a good deal.
A margin of safety is an explicit acknowledgment of the uncertainty in any valuation estimate — not a claim that the calculation is precise. The less predictable the business itself (volatile earnings, a fast-changing industry), the larger a margin needed to compensate for that higher uncertainty.
If a DCF model (see How to Tell If a Stock Is Overvalued — A Practical Framework) shows a fair value only 10% above the current price, that's a very thin margin of safety — a 40-50% gap gives a much bigger cushion against wrong assumptions.
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This research is intended for general educational purposes only, does not constitute investment advice, and is not a prediction. Full details on the disclaimer page.