A safety-first approach to value investing

Legendary value investor Benjamin Graham had great success with his "margin of safety" approach to stock picking. But does it still work today, asks Matthew Partridge.

The concept of a "margin of safety" in investing was first introduced by value investors Benjamin Graham and David Dodd in their 1934 book Security Analysis, and was more widely popularised by Graham in his book The Intelligent Investor. In essence, it says that the soundest way to invest is to buy stocks that are selling at a substantial discount to their "intrinsic value". This way, even if market sentiment sours or the economy slows, the investor should still be protected.

Of course, this is easier said than done. Before you can judge whether a share is overvalued or undervalued, you need to work out what its actual fair value should be. In theory even a firm with a high price/earnings (p/e) ratio could have a solid margin of safety if its expected earnings justify a high valuation. However, because most people tend to be overly optimistic about future returns, most value investors emphasise the importance of buying shares that are cheap based on simple measures such as book value (net assets).

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Dr Matthew Partridge
Shares editor, MoneyWeek

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri