Tuesday, September 12, 2006

Seth Klarman

Value Investing - A risk-averse investment approach designed to buy securities at a discount from underlying value

Margin of Safety - Investing at considerable discounts to underlying value, an individual provides himself or herself room for imprecision, bad luck, or analytical error (i.e. “margin of safety”) while avoiding sizable losses

Seth Klarman, Margin of Safety, Glossary, 1991

Seth Klarman’s Margin of Safety has been getting some press lately. The book was highlighted in an article in the August 7th issue of BusinessWeek. The Globe and Mail featured an article on the book on August 12th.

I had found out about Klarman and his book years ago while I was researching investment books to buy to add to my library. However, the book has been out of print since 1991. You can buy a used one at Amazon these days for about USD $1,000. No thank you.

So you can imagine why I was in disbelief when one day in early August I found myself walking down Bay Street, on my way to the office, with a copy of the book in hand. Just the night before, I had received a text message from my brother, who didn’t know about my meeting earlier that morning, alerting me to the BusinessWeek article. Talk about coincidence. The book belongs to Carl, the head of US equities research and portfolio manager of US equity funds at a prominent Canadian investment management firm. A few days before my brother’s text message, Carl had emailed me after having discovered my blog and we had agreed to meet for a chat.

Carl’s books were stacked on top of each other in the corner of his office. I took a quick glance and recognized a bunch of them. But I hadn’t noticed Klarman’s book. When Klarman later came up in conversation, Carl offered to lend me the book. Thanks Carl.

The book is a quick read and it is a classic. Klarman is a true Graham disciple. There is a fantastic chapter on investing in distressed and bankrupt securities. He emphasizes the importance of holding cash and being patient, the need to evaluate one’s portfolio against emerging investment opportunities which may be better bargains, and why it is crucial to ignore Wall Street’s latest financial innovations and gimmickries. There is also a section on a very important principle which many investors fail to grasp: “the first 80% of the available information is found in the first 20% of time spent.” Digging in too much can mean lost opportunity. As long as you leave yourself a decent Margin of Safety, you will be fine.

Klarman does an excellent job making the case for value investing and how one may profit by adhering to the discipline. However, he reminds us that not everyone is wired to succeed at it. Being a contrarian can be a lonely and psychologically challenging endeavor at times. Here is the conclusion of the chapter on value investing and the importance of Margin of Safety: “Value investing is simple to understand but difficult to implement. Value investors are not supersophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value. The hard part is discipline, patience, and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.”

1 comment:

Eclectic Contrarian said...

Not to sound crude, but in addition to those 3 characteristics, I might also add balls-- having the balls to take a big swing when the ball is slowly, gently coming over the plate.

Many investors probably invested in industrial machinery companies before the rust belt revival. It was Jeff Gendell over at Tontine that put a very large proportion of his portfolio value in an array of steel manufacturers, regional banks and industrial machinery producers, making his overall portfolio a multi-bagger in a short period of time.

Great blog. Do keep it up.