Deep Value Investing, Fundamental Risks, and the Margin of Safety

How much margin of safety should a value investor demand? In addition to market price volatility, this article identifies three sources of fundamental risk: (i) risk that interim news may necessitate revision of an initial valuation estimate before profits can be taken; (ii) uncertainty over the reliability of a value estimate; and (iii) uncertainty over when market price will converge to the investor's value estimate. Applying the model to S&P500 firms reveals that, while investors should demand margins of safety that are typically 20%-35% of the share price, larger margins are sometimes justified for especially risky businesses.