Rule #1 Finance Blog

With Investor Phil Town

InvestED: Ep. 46- Most Important Words In Investing: Margin of Safety

This week, we dive straight into a Margin of Safety analysis to evaluate a company’s future with simple financial calculations. In order to know what we’re buying is a good deal, we need to be able to project what it will be worth in the future.

In Episode 46 You Will Learn

  1. Why Warren Buffett believes ‘Margin of Safety’ are the most important words in investing.
  2. How to calculate margin of safety.
  3. How to calculate the growth rate of our hypothetical lemonade stand from Episode 45.
  4. How companies try to fool you by making their earnings appear larger than they really are, and what to do about it.
  5. How to average out the growth rate of a company.
  6. How to calculate the first half of a Discounted Cash Flow (DCF).
  7. Why investing should not be like gambling.

Show Links

Episode 23 Margin of Safety

Episode 45- Lemonade Stand Example

Price/Earnings Ratio

Margin of Safety Notes

Things you need to know in order to calculate margin of safety:

1. Current earnings for last 12 Months –Trailing Twelve Months Earnings (TTM Earnings).

  • With where the company has been, we can predict where it’s going to be.

2. Growth rate of earnings through 10 years.

  • If you can’t predict it, the company might be too volatile

3. Price Earnings Ratio (P/E Ratio)

  • Will get bigger if a company is growing vs. not growing.
  • Public companies sell for about double what a private company sells for.

4. Minimal acceptable rate of return (MARR).

  • Finding how much to pay for business today given the projected growth rate in future.
  • Rule #1 standard minimum acceptable rate of return is 15% rate of return.

Growth Rates of our Hypothetical Lemonade Stand

  1. Sales Growth Rate- 13%
  2. Earnings Growth Rater- 13%
  3. Free Cash Flow Growth Rate- 15%
  4. Book Value Growth Rate- 20%

What is an acceptable growth rate for the company if this lemonade stand grows like it did in the past?

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On the InvestED podcast, Phil and his daughter Danielle shine a light on the successful investing strategies that gurus like Warren Buffett have used for 80 years. Listen in for a great stock market education on basics, learn how to invest on your own, and follow along with real-time examples and investing tips from week to week.