Wednesday, November 25th, 2015

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Margin of Safety Key to Long-Term Investment

Warren Buffett calls margin of safety the three key words of investment.Investors have had a difficult time in recent years as the market experiences volatility. The Motley Fool argues that anyone looking to delve into the stock market should have patience and hold stocks for the long term, but also respect Warren Buffet’s three key words of investing: margin of safety.

Margin of safety is the difference between the real value of the company the value that the company is currently trading at. When companies garner a great deal of hype they can often attract speculators, inflating the price beyond the fundamentals.

The Motley Fool offers Australian hearing device company Cochlear as an example, with a trading price to earnings ratio over 20. This reflects a company that is susceptible over the long term to shocks, such as the recent recall that could seriously damage the manufacturer’s sales.

Instead, the site recommends taking advantage of these periods of uncertainty and volatility to invest in strong companies with good long-term prospects at low prices.

Professor Richard Sylla of New York University’s Stern School of Business made a similar argument to The Wall Street Journal, noting that prior trends suggest stock prices will bottom out in coming years and then begin to recover. Particularly for people who do not need the money in the short term, this represents a good time to invest for retirement and other long-term interests.

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