The Business of Value Investing.pdf

Effective Business Valuation 95

i nvestors, a declining stock price accompanied by a stable intrinsic

value actually gives investors less risk because the margin of safety is higher.

So, the question on many investors ’ minds is: How and when

will the stock price reach intrinsic value?

The concept of a margin of safety will be more meaningful and

understandable after the discussion on intrinsic value, which is the

next concept to be covered. Keep in mind that a margin of safety

is affected by the intrinsic value of the business. When the intrin-

sic value changes, so does your margin of safety, and you ’ ll need to

determine whether to keep holding the investment or dispose of it.

Any further attempt at investing intelligently becomes useless

and potentially disastrous if you do not incorporate the concept of

a margin of safety. Intrinsic values, discounted cash fl ow assump-

tions, and other fundamental tools are ineffective if you forget the

concept of a margin of safety. Everything you will read in this book

centers around this fundamental concept; never forgot it in any sin-

gle investment consideration.

Value Investing 201: Intrinsic Value

To have a satisfactory margin of safety, you fi rst must determine a com-

pany ’ s intrinsic value, because a margin of safety occurs only when a

business can be acquired at a signifi cant discount to its intrinsic value.

The wider the gap, the stronger the margin of safety. Warren Buffett

likes to invest with a 50 percent margin of safety. Mason Hawkins at

Longleaf Partners says his group looks for businesses trading at 60

percent or less of intrinsic value. The key focus is to look for opportu-

nities with the widest degrees of margin of safety.

Intrinsic value is a term that is often cited by value investors. It ’ s

a very important concept because all investment decisions should

be based on the current market value of the business — the number

of shares outstanding multiplied by the current stock price —

relative to the true intrinsic value of the business.

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