Why is it often difficult to achieve a margin of safety when buying 'growth stocks'?

Okay, let's talk about this. This is an excellent question, hitting right at a core puzzle in value investing. I'll try to explain it clearly in plain language.

Why is it Often Hard to Get a Margin of Safety with "Growth Stocks"?

Think about it, buddy. When we go to the market to buy something, say a pound of apples. The vendor says it's 5 bucks a pound. You size them up, think they look pretty good and worth the price, but you're worried the scale might be off or there might be a few bad ones. So you haggle: "Boss, how about 4.5? Can you do it for 4.5?" If the vendor agrees, that saved 50 cents is your margin of safety. You bought it for less than its real value, so you feel secure. Even if you find a small bruise when you get home, you don't feel cheated.

The concept of "margin of safety" is the core idea of the great Benjamin Graham: "Buy something worth a dollar for 40 cents." That discount is your cushion. Even if you misjudge it and it's really only worth 80 cents, you still come out ahead.

Alright, now that we understand "margin of safety," let's look at "growth stocks."

What is a Growth Stock?

A growth stock is like the "star student" in class that all the teachers and classmates are bullish on. Nobody doubts they'll get into Tsinghua or Peking University, maybe even become a scientist or a big CEO. Their potential is huge, and their future seems incredibly bright.

Reflected in the stock market, growth stocks are companies with rapidly expanding businesses and soaring profits year after year. Think of companies like Tencent or Apple in their early explosive growth phases, or some current AI or new energy companies today.

Here Comes the Contradiction: Why Won't the "Star Student" Give You a Discount?

That's exactly the problem. Because everyone sees this "star student's" potential, everyone wants to "build a relationship" (buy their stock). What happens to the price of something everyone wants?

The answer is: Not only is there no discount, but you often pay a premium!

It's difficult to get a margin of safety when buying growth stocks, mainly for these reasons:

1. You're Paying Not for "Now," but for the "Distant Future"

When you buy stock in an ordinary company, like a mature bank or a power plant, you're buying its current earning power and assets. It's like buying a pre-owned apartment – the location, size, lighting are all clear, making valuation relatively straightforward. You can easily estimate its approximate worth and then look for a discounted opportunity based on that.

But buying a growth stock is different. You're buying its future glorious potential. Its stock price doesn't just include its current value; it incorporates, much more significantly, the "rosy expectations" everyone has for its high-speed growth over the next 10, 20, or even more years.

This is like buying a "future prime oceanfront apartment" that's still on blueprints. The developer tells you that a subway will be built here, there will be top-tier malls, prestigious schools... It sounds incredibly tempting, but the price already factors in all those "future positives." You're paying for a blueprint.

Where's the risk? The future is highly uncertain. What if the subway plan changes? What if the mall fails to attract tenants? What if the economy cools off and no one wants beachfront property anymore? If any of these things happen, the value of this "blueprint" plummets, and the high price you paid means you're stuck "holding the bag" or "catching a falling knife."

2. The Market is Too "Crowded"; Good Things Rarely Sell at a Bargain

The essence of a margin of safety is "finding a bargain," exploiting the market's mispricing. But with growth stocks, the market's error is usually over-optimism, not over-pessimism.

Everyone knows it's a good company. Analysts use complex models to project its future, and the media constantly reports on its innovations. In this high-visibility spotlight, it's extremely hard to find an overlooked, undervalued opportunity.

It's like a limited edition hype sneaker. Everyone is competing to buy it on release day; getting it at retail price requires lottery-like luck, let alone a discount. Growth stocks are the "limited edition sneakers" of the stock market – those who own them feel they hold the future; why would they sell it cheaply?

3. "Expectations" are Extremely Fragile

The high stock price of a growth stock is built on the expectation of "rapid growth." This expectation is like an oversized balloon – beautiful to look at but easily popped by a needle.

Growth simply slows down: Even if it drops from 50% annual growth to 30% (itself an impressive rate!), the market panics – "The story is broken!" The expectation collapses, and the stock might crash. Because the initial valuation factored in 50% growth; failing to meet that necessitates a re-evaluation.
A strong competitor emerges: If a powerful rival appears, concerns about market share loss will reduce future growth expectations.
Industry regulations change: A policy shift can instantly alter the entire growth narrative of an industry.

Therefore, investing in growth stocks requires not only correctly judging that the company itself is excellent now, but also that it can consistently and continuously exceed everyone's expectations for a very long time. This is incredibly difficult – practically betting on a perfect future.

Bottom line

Simply put, Graham's margin of safety is like treasure hunting in a discount outlet or flea market, focusing on "what is this thing worth right now, and for how much less can I buy it?"

Investing in growth stocks, however, is more like bidding at an art auction for a masterpiece, focusing on "how much will this painting be worth in the future, and how much am I willing to gamble right now?"

So, it's not that growth stocks are bad. Even Buffett evolved, investing in excellent growth companies like Apple. But he emphasizes "buying wonderful companies at a fair price", not "buying the dream at any cost." Finding that "fair price" itself requires exceptional judgment and deep industry understanding. For the average person, this kind of "margin of safety" becomes very vague and difficult to grasp.

For us ordinary folks, buying a proven product at a 20% discount often feels much more comfortable than chasing a trendy item trading at 2-3 times its current worth. This principle holds true in investing.