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Time To Go Back To Basics

back to basics chalkboardDuring 2009, we could buy almost anything in the stock market and might still made some money. Now, that might be a little harder. The Straits Times Index (SGX: ^STI) has since appreciated more than 100% since its lowest point in March 2009. As market climbs higher, many investors are relaxing their valuation method; this makes this the perfect time to go back to basics.

The Margin Of Safety

The margin of safety is the most basic and yet most important factor in valuation. Whatever price we estimate the value of a company to be, we should add some buffer to our entry price just in case we get it wrong (which we often do). There is no universal rule on how much margin of safety investors should discount before buying into a company, investors can come up with a discount they are personally comfortable with.

DBSVickers Securities recently published a research report on Sembcorp Marine (SGX: S51) maintaining their buy rating on the company with a target price of S$4.80 per share. During the time of the report, the company is trading at around S$4.06 per share. Therefore, it means that there is about 15% margin of safety built into their valuation. I have always make it a point to only use a research report or other people’s opinion on a company as a starting point for my own analysis. This is because valuation is very personal and there are many different assumptions each investor can assume when valuing a company.

The Intelligent Investor

Benjamin Graham first coined the idea of “Margin of Safety” in his book The Intelligent Investor. According to him, the use of margin of safety in our investment is one of the kind differences between investing and speculating. Margin of safety provides some cushion between what an investor estimates the company is worth compared to how much she bought the company for. In this sense, an investor who invests with a margin of safety in mind will be more able to withstand the shock if the company or industry fell into hard times.

Foolish Bottom Line

Given that valuation of companies have all moved up quite significantly over the past few years, it will be wiser if investors stick to the concept of margin of safety just when bargains are harder to come by.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.