Deep-Value Investing, Fundamental Risks, and the Margin of Safety
Posted: 11 Sep 2008
Date Written: September 9, 2008
This article estimates the margin of safety for publicly traded companies. In addition to market price volatility, the model identifies three sources of fundamental risk: 1) risk that interim news may necessitate revision of an initial valuation estimate before profits can be taken; 2) uncertainty over the reliability of a value estimate; and 3) uncertainty over when market price will converge to the investor's value estimate. The model indicates that, while investors should demand margins of safety that are typically 10% to 25% of the share price, larger margins are justified for especially risky stocks.
Keywords: margin of safety, value investing, idiosyncratic volatility, convergence
JEL Classification: D52, D81, D82, G11, G12, G14
Suggested Citation: Suggested Citation