We are considering a Margin of Safety while Buying to allow for human error or volatility.Should we consider the same before Selling also?
And one more, if the stock faces a risk of 80% in attaining the growth and profitability objectives, can we consider 20% or more as Margin of Safety.
Is this the right way to consider Margin of Safety (or) MOS does not have anything to do with Risk?
in my opinion, investors should build in margin of safety for both buying and selling.
I am not sure if there can be a mathematical approach to MoS. Seth Klarman writes : "Because investing is as much an art as a science, investors need a margin of safety. A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world. According to Graham, "The margin of safety is always dependent on the price paid. For any security, it will be large at one price, small at some higher price, nonexistent at some still higher price."
What is the requisite margin of safety for an investor? The answer can vary from one
investor to the next. How much bad luck are you willing and able to tolerate? How much volatility
in business values can you absorb? What is your tolerance for error? It comes down to how much
you can afford to lose.
hope this helps
Thanks for your reply.So , if am getting a risk score of 7 out of 10 for a particular stock, can i consider a Margin of Safety of 30% or more
And for the Risk Matrix, i opt for a Weighted average method as per below factors:
- Industry Risk - Cyclicality Risk, Competition Risk, Regulatory Risk
- Business Risk - Product Diversification, Raw Material, Currency Risk, Employee Satisfaction, Licenses, Brand Loyalty
- Management - Transparency, Promoter Pledging, Promoter Salary, Loan to Relatives & Subsidiaries, Capital Allocation
Is this a correct method?
Answer to this question has some nuances to it. It depends on the type of stock.
For value stocks(Graham style or low PE stocks) or opportunistic bets, sell decision is when 1. It has risen too fast 2. Moved to higher PE than historic PE 3. Risen close to your original projections and very low returns expected in the near future.
For stocks with deep moats, one needs to follow a patient and long term approach. Before buying one needs to build a rough and conservative estimate(with enough MOS). After buying and if the company has a good moat, it is possible that it can quickly bypass your initial projections and has given superior results. Now in this case one shouldn’t sell immediately. First check if the company’s performance is because of the factors it was assumed in the initial hypothesis or some other factors. Check all the initial assumptions. Now fine tune them. Basically one needs to re look the business with new assumptions and not hold on to old assumptions with which one bought the stock.
For a detailed discussion of the same do read the below link (explained well by Prof. Sanjay Bakshi)