Scott Tominaga: Investing with Margin of Safety

 

Scott Tominaga on Understanding Margin of Safety

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The margin of safety in investing is crucial. It represents the percentage variance between a stock's intrinsic value and its current market price. A wider margin of safety provides a cushion against potential errors in optimistic valuation assumptions, thereby safeguarding your investment from undue risks. By carefully considering this factor, investors can enhance their chances of making sound investment decisions and protecting their capital in the volatile world of stock markets. If the current price is $7.50 per share and the intrinsic value is $10 per share, then there is a margin of safety of 25%, explains Scott Tominaga. It's worth noting that intrinsic value is not concrete. It is the sum of subjective inputs and could vary widely depending on the analyst.

The higher the margin of safety, the less risk in your investment. Theoretically, a stock with a 60% margin of safety will fall less than a stock with no margin of safety.

Understanding the margin of safety

Using the margin of safety as a guiding principle in investment decisions is a cornerstone of value investing. While this approach is commonly associated with value investing, it's interesting to note that growth investors also recognize its importance and consider the concept in their analyses.

Value investors generally use one of the methods below to find a stock's intrinsic value:

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Discounted Cash Flow (DCF): With the discounted cash flow model, you project 10 years of future cash flows, notes Scott Tominaga. You then discount the numbers because the money you have now is most probably worth more than the money you might have in the future. The intrinsic value is the sum of the projected future cash flows.

Multiples: Multiples such as price/earnings, price/book, or price/sales allow you to compare the stock with its competitors or the overall market. If the stock has a lower multiple than similar stocks or the overall market, it could have a margin of safety.

Liquidation value: The only way to value some stocks is to discount some of the assets to fair market value and determine what the whole company would go for if sold or broken up, adds Scott Tominaga.

Scott Tominaga is a professional in the hedge fund and financial services industry and is responsible for all aspects of back-office operations daily, including investor relations and marketing. Learn more about Scott and his background in investment by visiting this page.