A few thoughts on Margin of Safety

A margin of safety is the margin of undervaluation of the market price to the intrinsic value. In some cases a quantitative analysis of a security will indicate a false margin of safety. The falseness can go in both directions (under- and overestimates).

 

Common situations in studying Free Cash Flow Yields

 

A low cash flow yield (price to last book year´s free cash flow)

  • Free cash flow is expected to grow and the market has priced it already
  • The companys operations are capital intensive with high barriers of entry (such as utilities)

A high cash flow yield

  • The company doesn´t pay dividends and has a bad reputation of reinvesting excess cash
  • The company is expected to have lost earnings power

 

Common situations in studying Net Asset Value

 

A security is trading under Net Net Current Asset Value

  • The company is expected to take on a big loss in the future
  • The company has off balance sheet liabilities

 

A security is trading well over book value

  • The compay´s operations require little capital. High return on equity.

 

Any comme nts are very welcome.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s