On Margin of Safety

Once I have determined that there is a sufficiently strong and sustainable economic moat surrounding the "business of interest", the next thing is to decide what price to buy it.

We determine the value of the business for ourselves and then compare to market price, if the market price is less than the value, we say the business is undervalued. (like when we go shopping and we see some discount and determine that it is a bargain). If the market price is more than the value, then its overvalued.

The difference between the market price and the value is our margin of safety. The larger the better as it means how much of a bargain we are getting the business at the prevailing price.

When determining the value of the business, value investors use anything from simple ratios like the PE and/or PB ratio, to more sophisticated means like the discounted cash flow method. 

Note: On top of the economic moat & margin of safety considerations, I also pay special attention to Dividends and Debt Levels

Dividends - My primary purpose is to invest for passive income, hence I am quite biased towards a business that pays good dividends.  On my watch-list, quite a number of them are "dividend stocks" and REITs that pay generous dividends.

Debt Levels - Being risk adverse, I am uncomfortable to see businesses with high level of debts. Hence I can sometimes be quite biased towards businesses that are net cash.  Higher level of debts usually means taking on more risks for the company, and question is always whether it can survive an economic crisis.

There are other things that I look out for in a business when I invest, but to keep things simple (and probably also because I am lazy =P) I have highlighted only the key ones above.

To learn more about value investing for beginners like myself, I would recommend starting off with the book on "value investing for employees" by Clive Tan which I find offering a very sound framework and an easy read.  Its a book on value investing written by a Singaporean for Singaporeans (it includes the Singapore context when discussing some of the details which can be very useful as the Singaporean reader can easily relate to them).