## Monday, August 20, 2007

### The Effect that Buying with a Margin of Safety has on Your Returns

A little math for a Monday morning:

Buy a stock at 50 percent (1/2) of intrinsic value, sell at 90 percent of initial intrinsic value:
IRR if it takes 2 years: 34.16%
IRR if it takes 3 years: 21.64%

Buy a stock at 67 percent (2/3) of intrinsic value, sell at 90 percent of initial intrinsic value:
IRR if it takes 2 years: 16.19%
IRR if it takes 3 years: 10.52%

Buy a stock at 50 percent (1/2) of intrinsic value, sell at 120 percent of initial intrinsic value (value increased):
IRR if it takes 2 years: 54.92%
IRR if it takes 3 years: 33.89%

Buy a stock at 67 percent (2/3) of intrinsic value, sell at 120 percent of initial intrinsic value (value increased):
IRR if it takes 2 years: 34.16%
IRR if it takes 3 years: 21.64%

It is interesting to note that buying a dollar's worth of value for \$0.50 and selling it for \$0.90 after 2-3 years, is the equivalent (on a return basis) of buying a dollar's worth of value for \$0.67 and selling it for \$1.20 after 2-3 years. This a good illustration of why you should require a larger margin of safety for a business that is not growing its intrinsic value, and be willing to pay a little more for a business that is growing its intrinsic value.