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Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Investors are all too often lured by the prospect of instant millions and fall prey to the many fads of Wall Street. The myriad approaches they adopt offer little or no real prospect for long-term success and invariably run the risk of considerable economic loss - they resemble speculation or outright gambling, not a coherent investment program. But value investing - the strategy of investing in securities trading at an appreciable discount from underlying value - has a long history - has a long history of delivering excellent investment results with limited downside risk. Taking its title from Benjamin Graham's often-repeated admonition to invest always with a margin of safety, Klarman's 'Margin of Safety' explains the philosophy of value investing, and perhaps more importantly, the logic behind it, demonstrating why it succeeds while other approaches fail. The blueprint that Klarman offers, if carefully followed, offers the investor the strong possibility of investment succe
248 pages, Hardcover
First published October 1, 1991
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About the author
Seth A. Klarman
8 books126 followersSeth Klarman is an American hedge-fund manager and a billionaire who founded the Baupost Group, a Boston-based private investment partnership, and the author of a book on value investing titled Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. Klarman is a graduate of Cornell University and Harvard Business School where he was a Baker Scholar.
Klarman grew up in a Jewish family in Baltimore, where his father was a public health economist at Johns Hopkins University and his mother taught high school English.
Klarman grew up in a Jewish family in Baltimore, where his father was a public health economist at Johns Hopkins University and his mother taught high school English.
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June 26, 2014
Top 5 Quotes / Thoughts:
1. Page 5: “You don’t understand. these are not eating sardines, they are trading sardines” [Difference between investment (buying stream of cashflows) and speculation (return solely dependent on re-sale).]
2. Page 81: “Buffet’s first and second rules of investing: 1) don’t lose money; and 2) never forget the first rule” [Don’t expose yourself to appreciable loss of principal. Make sure that your downside is bounded (Taleb).]
a. Compound interest is the 8th wonder of the world – mathematically better to earn 16% p.a. for 10-years than to earn 20% p.a. for 9-years and then lose 15% in year-10. You may ‘lose’ for 9-years out of 10, but in the long-term you will streak ahead)
3. Page 84: “The future is uncertain… Investors must be willing to forego some near-term return, if necessary, as an insurance premium against unexpected and unpredictable adversity”
a. Page 119: “avoid confusing precise forecasts with correct forecasts” (disdain false precision – Thorndike)
b. Page 218: “there is only one valid rule for selling: all investments are for sale at the right price” (similar to Outsiders)
4. Page 112: “risk is the perception of the probability of loss and the potential magnitude of loss” (no investment itself is inherently risk, risk is a function of price)
a. Page 110: “Low risk-high-return opportunities exist…” (Three causes: 1) asymmetry of information; 2) difficult to analyse; 3) vendor or purchaser acting for reasons unrelated to value)
5. Page 143: “numbers are not an end in themselves. Rather they are a means to understanding what is really happening in a company” [the numbers don’t drive the people, people drive the drivers (Killian Hurley). Think more, calculate less. Numbers are meaningless outside their context, or without anything to compare them against]
a. Page 158: “most investors strive fruitlessly for certainty and precision… yet high uncertainty is frequently accompanied by low prices….”, also, “the value of in-depth fundamental analysis is subject to diminishing marginal returns” (the 80/20 rule). [We’d rather be roughly right than precisely wrong – Buffet. Don’t exclude factors simply because they are difficult to measure]
1. Page 5: “You don’t understand. these are not eating sardines, they are trading sardines” [Difference between investment (buying stream of cashflows) and speculation (return solely dependent on re-sale).]
2. Page 81: “Buffet’s first and second rules of investing: 1) don’t lose money; and 2) never forget the first rule” [Don’t expose yourself to appreciable loss of principal. Make sure that your downside is bounded (Taleb).]
a. Compound interest is the 8th wonder of the world – mathematically better to earn 16% p.a. for 10-years than to earn 20% p.a. for 9-years and then lose 15% in year-10. You may ‘lose’ for 9-years out of 10, but in the long-term you will streak ahead)
3. Page 84: “The future is uncertain… Investors must be willing to forego some near-term return, if necessary, as an insurance premium against unexpected and unpredictable adversity”
a. Page 119: “avoid confusing precise forecasts with correct forecasts” (disdain false precision – Thorndike)
b. Page 218: “there is only one valid rule for selling: all investments are for sale at the right price” (similar to Outsiders)
4. Page 112: “risk is the perception of the probability of loss and the potential magnitude of loss” (no investment itself is inherently risk, risk is a function of price)
a. Page 110: “Low risk-high-return opportunities exist…” (Three causes: 1) asymmetry of information; 2) difficult to analyse; 3) vendor or purchaser acting for reasons unrelated to value)
5. Page 143: “numbers are not an end in themselves. Rather they are a means to understanding what is really happening in a company” [the numbers don’t drive the people, people drive the drivers (Killian Hurley). Think more, calculate less. Numbers are meaningless outside their context, or without anything to compare them against]
a. Page 158: “most investors strive fruitlessly for certainty and precision… yet high uncertainty is frequently accompanied by low prices….”, also, “the value of in-depth fundamental analysis is subject to diminishing marginal returns” (the 80/20 rule). [We’d rather be roughly right than precisely wrong – Buffet. Don’t exclude factors simply because they are difficult to measure]
July 28, 2014
I read this book after reading "Fooled by Randomness", and that had left me wondering whether trading/investing is really purely random or can there really be method to the madness. Much to my delight, Seth Klarman does provide a sound method to achieve investment success that is based on business fundamentals than pernicious speculation, relying on the "wisdom" of the market. The book is a fascinating read, especially for someone with a non-finance background but fresh out of a B-School, where basic theoretical knowledge is covered but not how to actually go about investing in the real world whilst being risk-averse.
I hope to read Benjamin Graham's - The Intelligent Investor too, from which the book draws heavily the Value Investing methodology. The two are a must read for people who want to build a career in investing.
I hope to read Benjamin Graham's - The Intelligent Investor too, from which the book draws heavily the Value Investing methodology. The two are a must read for people who want to build a career in investing.
June 17, 2012
Anyone interested in taking a hands-on approach to their portfolios would benefit from Klarman's guidance in Margin of Safety. The author likens Wall Street to a casino full of speculators with odds stacked in their favor, and against the individual investor that tries to compete on uneven ground. The opening line is a quote by Mark Twain: "There are two times in a man's life when he should not speculate--when he can't afford to and when he can." Klarman implores the reader to implement and follow a process (several of which are outlined in the book) instead of bouncing among speculative strategies that are better left to institutions, or preferably no one at all.
The book's common sense can be summed as do the homework necessary to know a stock's value, assume you're wrong and haircut that value, then wait for the market to offer the haircut price. Other approaches are unsustainable. He discusses past market environments that provided great opportunity for value investors to show that they do occur and this strategy does work. My one criticism is against Klarman's sharp criticism of index funds, as I believe they are a reasonable cost-effective choice for many hands-off investors. However, the pros in this book far outweigh the cons, making Margin of Safety a good read for current and aspiring investors.
The book's common sense can be summed as do the homework necessary to know a stock's value, assume you're wrong and haircut that value, then wait for the market to offer the haircut price. Other approaches are unsustainable. He discusses past market environments that provided great opportunity for value investors to show that they do occur and this strategy does work. My one criticism is against Klarman's sharp criticism of index funds, as I believe they are a reasonable cost-effective choice for many hands-off investors. However, the pros in this book far outweigh the cons, making Margin of Safety a good read for current and aspiring investors.
April 30, 2020
The original value investor Benjamin Graham's current equivalent is this guy: Seth Klarman. Some may think that Warren Buffet is applying Graham's principles, but more than anyone Klarman really mirrors Graham's thinking.* Like Graham, Klarman grew up Jewish on the East Coast. Both did well in school and had plenty of opportunities in academia but decided to take to money management instead. Like Graham, Klarman's greatest claim to fame was this book he published: Margin of Safety- Risk Averse Strategies for the Thoughtful Investor bleck! What an unappealing mouthful of a name! I just call it the Thoughtful Investor.
The weird thing about the Thoughtful Investor is that the book itself is kind of an object lesson in investing. If you look on Amazon right now its selling for about $2000 used! As happens with many stocks this thing is way over-valued and if you are a real value investor you wouldn't think of paying that much for a silly book. I think this also is telling of the kind of ridiculous thinking that goes on among the types of people have their head in finance. People in these circles produce the outrageous thinking that paying crazy amounts of money for something so simple could actually be worth it! If you want to read the book and are a normal human being that doesn't throw around $2000, just look for it online, there are PDF's of the text floating around out there or e-mail me and I'll send you a copy.
So what does Klarman talk about that is so valuable? Really, its mostly a modern, version of The Intelligent Investor. The language is more polished, and the approaches are more up to date, but the principles are much the same. Where Graham used Price/ Earning, Book Value and Dividends, Klarman uses Net Present Value, Liquidation Value and Stock market Value to gauge price. He defines Net Present Value as the discounted value of all future free cash flows a business is expected to generate. Klarman also mentions private market value as a rule of thumb which I completely agree with, to give an idea of a businesses value when the market's going nuts. One useful resource I've found for private company info http://www.privco.com/ Klarman also brought to my attention spin-offs as a re-occurring source of investing opportunities.
Even though Klarman isn't as original as Graham, he makes some great points and brings a modern intellect to Grahams principles. He has greatly added to the value investing cannon by writing and practicing value investing and is definitely a heavy hitter in the world of finance. Also unlike Graham, Klarman is still active, you can look at his current interest at his fund www.baupost.com.
*One difference I see between Buffet and Klarman is their holding time. Klarman thinks its necessary to "continually compare their current holdings in order to ensure they own only the most undervalued opportunities available." Buffet says "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." I think Buffet is a less likely to sell just because he sees something better out there, while Klarman might try a little too hard to demand the best bargain as did Graham.
Klarman also says: "Few value investors own technology companies, banks or insurance companies because they have un-analyzable assets and liabilities." If he sticks to this, it would be a huge difference between him and Buffet, Buffet obviously has no problem investing in banks like Wells Fargo and his first and most successful investments were GEICO and Illinois National Bank and Trust.
And finally, Klarman demands hard assets to provide safety while Buffet is more comfortable with a strong moat whether its tangible or not.
My favorite quote: "Value, like beauty is often in the eye of the beholder."
Other quotes that I found interesting, useful or just plain liked in his book:
Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.
Some people act responsibly and deliberately most of the time but go berserk when investing money. It may take months or years of work and discipline to earn the money and only a few minutes to invest it. Some spend more time buying a stereo or camera than buying stocks. Many regard the stock market as a way to make money without working rather than a way to invest capital in order to earn a decent return.
Greedy short-term-oriented investors may lose sight of a sound mathematical reason for avoiding loss. It is very difficult to recover from even on large, loss, which could literally destroy all at once the beneficial effects of many years of investment success.
Downfalls For Institutional Investors: Size, Self Imposed Constraints and Willful Ignorance of Fundamental Analysis.
I believe indexing will turn out to be just another Wall Street fad. (REALLY??!!)
Above all, investors must avoid swinging at bad pitches.
If the prevailing stock price is not warranted by the underlying value, it will eventually fall.
Value investors are not super sophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value. The hard part is discipline to avoid the many unattractive pitches, patience to wait for the right pitch and judgment to know when to swing.
There are only a few things investors can do about risk: diversify adequately, hedge when appropriate and invest with a margin of safety.
Many investors insist on affixing exact values to their investments, seeking precision in an imprecise world, but business value cannot be precisely determined.
How do value investors deal with the analytical necessity to predict the unpredictable? The only answer is conservatism.
Investors relying on conservative historical standards of valuation in determining private-market value will benefit from a true margin of safety, while others’ margin of safety blows with the financial winds.
Like Einstein’s theory of relativity this (Soros's theory of reflexivity) may slightly affect calculations but only in rare or extreme circumstances, and for the most part fundamental analysis is still on largely right.
Spinoffs seem to frequently be undervalued and large emerging industries seem to be frequently overvalued like railroad companies were, air freight was, computer companies were.
...it is important to remember that numbers are not an end in themselves. Rather they are a means to understand what is really happening in a company.
Good investment ideas are rare and valuable things, which must be ferreted out assiduously.
Value investing by its very nature is contrarian. Value investing exists where the herd is selling, unaware or ignoring.
Information generally follows the 80/20 rule: the first 80 percent of the available information is gathered in the first 20 percent of the time spent.
No one understands a business and its prospects better than the management.
Arbitrage is a riskless transaction that generates profits from temporary pricing inefficiencies between markets.
Although trading based on inside information is illegal, the term has never been clearly defined.
The weird thing about the Thoughtful Investor is that the book itself is kind of an object lesson in investing. If you look on Amazon right now its selling for about $2000 used! As happens with many stocks this thing is way over-valued and if you are a real value investor you wouldn't think of paying that much for a silly book. I think this also is telling of the kind of ridiculous thinking that goes on among the types of people have their head in finance. People in these circles produce the outrageous thinking that paying crazy amounts of money for something so simple could actually be worth it! If you want to read the book and are a normal human being that doesn't throw around $2000, just look for it online, there are PDF's of the text floating around out there or e-mail me and I'll send you a copy.
So what does Klarman talk about that is so valuable? Really, its mostly a modern, version of The Intelligent Investor. The language is more polished, and the approaches are more up to date, but the principles are much the same. Where Graham used Price/ Earning, Book Value and Dividends, Klarman uses Net Present Value, Liquidation Value and Stock market Value to gauge price. He defines Net Present Value as the discounted value of all future free cash flows a business is expected to generate. Klarman also mentions private market value as a rule of thumb which I completely agree with, to give an idea of a businesses value when the market's going nuts. One useful resource I've found for private company info http://www.privco.com/ Klarman also brought to my attention spin-offs as a re-occurring source of investing opportunities.
Even though Klarman isn't as original as Graham, he makes some great points and brings a modern intellect to Grahams principles. He has greatly added to the value investing cannon by writing and practicing value investing and is definitely a heavy hitter in the world of finance. Also unlike Graham, Klarman is still active, you can look at his current interest at his fund www.baupost.com.
*One difference I see between Buffet and Klarman is their holding time. Klarman thinks its necessary to "continually compare their current holdings in order to ensure they own only the most undervalued opportunities available." Buffet says "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." I think Buffet is a less likely to sell just because he sees something better out there, while Klarman might try a little too hard to demand the best bargain as did Graham.
Klarman also says: "Few value investors own technology companies, banks or insurance companies because they have un-analyzable assets and liabilities." If he sticks to this, it would be a huge difference between him and Buffet, Buffet obviously has no problem investing in banks like Wells Fargo and his first and most successful investments were GEICO and Illinois National Bank and Trust.
And finally, Klarman demands hard assets to provide safety while Buffet is more comfortable with a strong moat whether its tangible or not.
My favorite quote: "Value, like beauty is often in the eye of the beholder."
Other quotes that I found interesting, useful or just plain liked in his book:
Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.
Some people act responsibly and deliberately most of the time but go berserk when investing money. It may take months or years of work and discipline to earn the money and only a few minutes to invest it. Some spend more time buying a stereo or camera than buying stocks. Many regard the stock market as a way to make money without working rather than a way to invest capital in order to earn a decent return.
Greedy short-term-oriented investors may lose sight of a sound mathematical reason for avoiding loss. It is very difficult to recover from even on large, loss, which could literally destroy all at once the beneficial effects of many years of investment success.
Downfalls For Institutional Investors: Size, Self Imposed Constraints and Willful Ignorance of Fundamental Analysis.
I believe indexing will turn out to be just another Wall Street fad. (REALLY??!!)
Above all, investors must avoid swinging at bad pitches.
If the prevailing stock price is not warranted by the underlying value, it will eventually fall.
Value investors are not super sophisticated analytical wizards who create and apply intricate computer models to find attractive opportunities or assess underlying value. The hard part is discipline to avoid the many unattractive pitches, patience to wait for the right pitch and judgment to know when to swing.
There are only a few things investors can do about risk: diversify adequately, hedge when appropriate and invest with a margin of safety.
Many investors insist on affixing exact values to their investments, seeking precision in an imprecise world, but business value cannot be precisely determined.
How do value investors deal with the analytical necessity to predict the unpredictable? The only answer is conservatism.
Investors relying on conservative historical standards of valuation in determining private-market value will benefit from a true margin of safety, while others’ margin of safety blows with the financial winds.
Like Einstein’s theory of relativity this (Soros's theory of reflexivity) may slightly affect calculations but only in rare or extreme circumstances, and for the most part fundamental analysis is still on largely right.
Spinoffs seem to frequently be undervalued and large emerging industries seem to be frequently overvalued like railroad companies were, air freight was, computer companies were.
...it is important to remember that numbers are not an end in themselves. Rather they are a means to understand what is really happening in a company.
Good investment ideas are rare and valuable things, which must be ferreted out assiduously.
Value investing by its very nature is contrarian. Value investing exists where the herd is selling, unaware or ignoring.
Information generally follows the 80/20 rule: the first 80 percent of the available information is gathered in the first 20 percent of the time spent.
No one understands a business and its prospects better than the management.
Arbitrage is a riskless transaction that generates profits from temporary pricing inefficiencies between markets.
Although trading based on inside information is illegal, the term has never been clearly defined.
November 24, 2013
Although I wouldn't spend $1000 for this book, he surprised me by summing up in a few simple sentences...
- how the mortgage tranched CDOs are flawed,
- how the rating agencies are claiming it was unforseeable, and
- how it could all blow up by a credit crunch.
But the most amazing part was that he did this in 1991 (when the book was published) and that is way before the mortgage CDOs were in full swing.
I just wish I had read the book earlier.
Brady Bunte
- how the mortgage tranched CDOs are flawed,
- how the rating agencies are claiming it was unforseeable, and
- how it could all blow up by a credit crunch.
But the most amazing part was that he did this in 1991 (when the book was published) and that is way before the mortgage CDOs were in full swing.
I just wish I had read the book earlier.
Brady Bunte
April 5, 2016
I had high hopes for this book since the ratings were amazing. However, I gave this book 2 stars because many of the ideas and concepts that were mentioned were already known to me. I also found this book more difficult to read than other investment books, perhaps due to the writing style.
July 12, 2019
When I saw someone reading this on the train to work one morning, I knew I should read it. It's exactly the kind of thing I'd be interested in. The fact that it turned out to be WAY out of print only fanned my desire to read it. Used copies go for hundreds of dollars! My library system didn't have it. I congratulated myself on using InterLibrary Loan to find some library in the US that did, only to find that it's so valuable no library was letting go of it, if their copy hadn't already been stolen. Finally, a helpful librarian pointed out there was a scanned copy available online as a Word .doc file, if I wanted to read it that badly. How was that even a question? I converted it to PDF and learned how to load independent PDFs on my Kindle so I could read it. What amazing secrets did it hold that old copies were so valuable, and what was the establishment trying to keep locked away by refusing to reprint such an obviously in-demand book?
And was it worth the badly OCR'd scan to get the content of this book whose sheer scarcity gave it legendary status in my mind? Yes, although not by as clear a margin as I expected. Here's why:
- It has the best takedown of the Efficient Market Hypothesis I've read.
- This is the first place I've read where the author explicitly mentions that, to be a value investor, you need to keep a supply of cash around. In other words, you should *not* be fully invested in the market. I figured this out from reading between the lines (stories about Warren Buffet kept mentioning his buying businesses and swaths of stock with cash during downturns and I thought to ask myself "where is he getting this cash to buy during a downturn?"), but it was nice to see it get mentioned as a necessary part of the strategy.
- The principles of value investing are reviewed here, but you can get those elsewhere, including the landmark The Intelligent Investor by the patron saint of value investing (Benjamin Graham).
- Similarly, Klarman talks about situations where an individual can find good value because there's even less competition than usual. These include spinoffs, bankruptcies, and mergers. This is interesting, but it suffers from being tough to act on and a lot of this got covered later in an easier to read way in Joel Greenblatt's You Can Be a Stock Market Genius, labeled as "special situations investing".
- The history of the junk bond bubble was new to me, and had some historical interest.
The writing ended up being kind of dry, which is the main reason it took me over 10 months to actually finish this book. I'm pretty sure that's a record for me!
And was it worth the badly OCR'd scan to get the content of this book whose sheer scarcity gave it legendary status in my mind? Yes, although not by as clear a margin as I expected. Here's why:
- It has the best takedown of the Efficient Market Hypothesis I've read.
- This is the first place I've read where the author explicitly mentions that, to be a value investor, you need to keep a supply of cash around. In other words, you should *not* be fully invested in the market. I figured this out from reading between the lines (stories about Warren Buffet kept mentioning his buying businesses and swaths of stock with cash during downturns and I thought to ask myself "where is he getting this cash to buy during a downturn?"), but it was nice to see it get mentioned as a necessary part of the strategy.
- The principles of value investing are reviewed here, but you can get those elsewhere, including the landmark The Intelligent Investor by the patron saint of value investing (Benjamin Graham).
- Similarly, Klarman talks about situations where an individual can find good value because there's even less competition than usual. These include spinoffs, bankruptcies, and mergers. This is interesting, but it suffers from being tough to act on and a lot of this got covered later in an easier to read way in Joel Greenblatt's You Can Be a Stock Market Genius, labeled as "special situations investing".
- The history of the junk bond bubble was new to me, and had some historical interest.
The writing ended up being kind of dry, which is the main reason it took me over 10 months to actually finish this book. I'm pretty sure that's a record for me!
March 10, 2013
Excellent. It was a far superior read the the intelligent investor as it 1) included all of the same ideas + some additional ones 2) wasn't sooo old, so the language was much clearer and easier to follow; 3) wasn't riddled with examples from the 60's(i.e. wasn't written from the perspective of being a "current" guide to the markets; 4) was significantly shorter/more concise.
December 29, 2024
A good book on value investing which is unfortunately a little short and perhaps lacking in depth in places
July 4, 2011
Margin of Safety is a famous phrase coined by Ben Graham half a century ago, and taken up by Seth Klarman here as a full volume. Unfortunately, this book is no longer in print, but I managed to score a copy without having to pay the $500 price advertised on amazon.com.
The book is in three parts. First, a strong case for fundamental value investing as the only sound framework for making investment decisions; second is a scathing critique of "institutional investing," culminating with Klarman's ridicule of the "relative performance derby"; the last section of the book is Klarman's suggested process for determining value, and the construction and maintenance of portfolios.
My favorite portion of this book is the critique of the "relative performance derby," and it's something I've gone back and re-read several times. This critique is nothing new in fact. Warren Buffett may have been one of the first to identify the problem in an annual letter to investors in his Buffett Partners fund, way back in 1964:
"In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity. I think it is much more a product of....an institutional framework whereby average is 'safe' and the personal rewards for independent action are in no way commensurate with the general risk attached to such action."
Klarman takes up this prescient observation and articulates clear and compelling reasons for how the investment management industry evolved to embrace mediocrity.
The book is in three parts. First, a strong case for fundamental value investing as the only sound framework for making investment decisions; second is a scathing critique of "institutional investing," culminating with Klarman's ridicule of the "relative performance derby"; the last section of the book is Klarman's suggested process for determining value, and the construction and maintenance of portfolios.
My favorite portion of this book is the critique of the "relative performance derby," and it's something I've gone back and re-read several times. This critique is nothing new in fact. Warren Buffett may have been one of the first to identify the problem in an annual letter to investors in his Buffett Partners fund, way back in 1964:
"In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity. I think it is much more a product of....an institutional framework whereby average is 'safe' and the personal rewards for independent action are in no way commensurate with the general risk attached to such action."
Klarman takes up this prescient observation and articulates clear and compelling reasons for how the investment management industry evolved to embrace mediocrity.
January 31, 2011
An excellent book written by an highly credible figure in the value investing world. I didn't always agree with the author. For example, I do think a long consistent track record of paying meaningful dividends is worth considering along with more direct value factors like P/E and P/B and I prefer the Graham/Lynch approach of diversifying into 20-30 stocks (versus focusing on 10 mega-picks) which I consider prudent and worth the slight reduction in potential return. However, I was extremely impressed with the thoughtful and consistent approach presented throughout and found myself nodding at much of what Klarman had to say.
All in all, MoS is a must read for all Graham and Buffet disciples. My only real complaint is that the book follows Graham's Intelligent Investor a little too closely. But in my humble opinion that's not a real negative since some of Graham's ideas can take a while to sink in and everyone can benefit from being hit over the head again with some good-ole Graham!
Make sure you download it in PDF form off the internet for free (the original is out of print). Happy reading!
All in all, MoS is a must read for all Graham and Buffet disciples. My only real complaint is that the book follows Graham's Intelligent Investor a little too closely. But in my humble opinion that's not a real negative since some of Graham's ideas can take a while to sink in and everyone can benefit from being hit over the head again with some good-ole Graham!
Make sure you download it in PDF form off the internet for free (the original is out of print). Happy reading!
February 12, 2015
Good introduction to value investing. The author dwells too much on what's wrong with other valuation methods without talking about how should an investor go about executing value investing. Pros of value investing are too less compared to cons of investing time analysing the underlying businesses. Book is not really targeted towards an audience and seems to wander between individual investor and institutional one. Recommended read but the content delivery is lacking coherence..
February 16, 2018
Great outline about how to think about investing, and less about specific strategies to invest. Provides great lenses to look at investing followed by illlustrative anecdotes. Some of the actual advice is a bit dated (but to be expected given the age of the book). This book is a must read if you are interested in learning about how value investors (of which Seth Klarman is a legend) think.
July 12, 2023
Fairly detailed, despite being quite to the point, on all key topics one would expect on the topic of investing. A bit more direct, or crass, on certain topics -which was refreshing.
September 10, 2018
A lot of wisdom from personal S.Klarman experience, illustrated with real examples. However I find this book more suitable for novice investors who seek basic knowledge on value investing principles
July 4, 2018
I don't know what I really expecting from this book. Old investing books rarely age well. But this was one "famous" so I wanted to check it out. The first part is a pretty painful rehash of the kind of introductory "most traders lose money" kind of stuff you can find done much better almost everywhere nowadays. Jonathan Clements, Jason Zweig, William Bernstein, Charles Ellis, Burton Malkiel, John Bogle, and so on.
Then Klarman provides his "antidote" which is....value investing in individual stocks. His strategy is basically: do investment research to find "value" things and then invest in those (which maintaining a margin of safety).
It isn't really a course I'd recommend to the average investor and I'm not sure it is something I'd really recommend to a value investor either. This really represents a historical document more than anything else. A view into the past when people believed that simply by reading financial documents (which, apparently, no one else does....) you'll be able to find good deals that no one else could and then, as a retail investor with very modest amounts of capital, be able to turn a profit.
Retail investors don't really have any business in any of the strategies he talks about -- investing in corporate liquidations, investing in "complex securities" (which he defines as "those with unusual cash flow characteristics") like a contigent-value rights issue from Dow Chemical to Marion Labs as part of an acquisition, investing in IPOs, selling interest rate futures, investing in risk arbitrage, investing in thrift conversions, investing in bankrupt businesses.
The book is a bit of a catch-22. The people who are equipped to invest in those things don't need to read this book. And anyone who needs to read this book to invest in them, shouldn't be investing in them. As Klarman himself notes, "Investing [ed. the way he suggests, that is] is a full-time job". If you don't want investing to be a full-time job -- maybe you already have a job or a family -- there's nothing really of value in this book.
The section on the importance of a personal relationship with your stock broker -- someone with "a willingness to sacrifice immediate commissions for the sake of long-term relationships" -- is especially quaint in a world where everyone trades online for free (or close to it).
Then Klarman provides his "antidote" which is....value investing in individual stocks. His strategy is basically: do investment research to find "value" things and then invest in those (which maintaining a margin of safety).
It isn't really a course I'd recommend to the average investor and I'm not sure it is something I'd really recommend to a value investor either. This really represents a historical document more than anything else. A view into the past when people believed that simply by reading financial documents (which, apparently, no one else does....) you'll be able to find good deals that no one else could and then, as a retail investor with very modest amounts of capital, be able to turn a profit.
Retail investors don't really have any business in any of the strategies he talks about -- investing in corporate liquidations, investing in "complex securities" (which he defines as "those with unusual cash flow characteristics") like a contigent-value rights issue from Dow Chemical to Marion Labs as part of an acquisition, investing in IPOs, selling interest rate futures, investing in risk arbitrage, investing in thrift conversions, investing in bankrupt businesses.
The book is a bit of a catch-22. The people who are equipped to invest in those things don't need to read this book. And anyone who needs to read this book to invest in them, shouldn't be investing in them. As Klarman himself notes, "Investing [ed. the way he suggests, that is] is a full-time job". If you don't want investing to be a full-time job -- maybe you already have a job or a family -- there's nothing really of value in this book.
The section on the importance of a personal relationship with your stock broker -- someone with "a willingness to sacrifice immediate commissions for the sake of long-term relationships" -- is especially quaint in a world where everyone trades online for free (or close to it).
November 11, 2015
Another great read for any Buffet "disciples" who are interested in value investing and security analysis.
Other than graham's own books, it's difficult to say that it was a quintessential read, but it packed a lot provided how short it was. Reiterating concepts of fundamental analysis including key ratios and discount cash flow, this book delivered the basics of value investing in a very concise manner. Aside from reviewing basic principles, and hearing the opinion of another experienced investor on this manner, there were two factors I that I appreciated in Klarman's book: emphasis on net working and liquid capital, and his lack of disdain towards taking advantage of arbitrage opportunities.
Buffet often speaks of only investing for the very long term in companies that have a very strong long-term track record. Companies are evaluated based on stability, consistency, growth and expectations from a product and financial perspective. However, two complicated questions are deciding when to buy and when to sell. When is a company undervalued? When is it not? How much should it be undervalued? By analyzing junk bonds, fallen angels, companies filing or on the verge of bankruptcy, it becomes very clear if a company is indeed undervalued if its assets were liquidized and when a buy is "obvious". Klarman's discussion of net working capital reminded me to always look at the most recent balance sheet and cash flow statement to see what the state of the company is, and what exactly I'm paying for.
Klarman's second point, though may potentially be indirect, is taking advantage of arbitrage opportunities. If a company is on the brink of bankruptcy, and is bound to shut down in a matter of years, it will most likely attempt to return as much cash as it can to its shareholders. Such opportunities may not be feasible long-term investments, but can produce very favorable short-term returns, and are definitely worth investigating.
All in all, I think this is an amazing book that's backed by a lot of experience. There is a lot to take away given how short it is, and I personally know that it made me a more disciplined and vigilant investor. Definitely a must read for any investor.
Other than graham's own books, it's difficult to say that it was a quintessential read, but it packed a lot provided how short it was. Reiterating concepts of fundamental analysis including key ratios and discount cash flow, this book delivered the basics of value investing in a very concise manner. Aside from reviewing basic principles, and hearing the opinion of another experienced investor on this manner, there were two factors I that I appreciated in Klarman's book: emphasis on net working and liquid capital, and his lack of disdain towards taking advantage of arbitrage opportunities.
Buffet often speaks of only investing for the very long term in companies that have a very strong long-term track record. Companies are evaluated based on stability, consistency, growth and expectations from a product and financial perspective. However, two complicated questions are deciding when to buy and when to sell. When is a company undervalued? When is it not? How much should it be undervalued? By analyzing junk bonds, fallen angels, companies filing or on the verge of bankruptcy, it becomes very clear if a company is indeed undervalued if its assets were liquidized and when a buy is "obvious". Klarman's discussion of net working capital reminded me to always look at the most recent balance sheet and cash flow statement to see what the state of the company is, and what exactly I'm paying for.
Klarman's second point, though may potentially be indirect, is taking advantage of arbitrage opportunities. If a company is on the brink of bankruptcy, and is bound to shut down in a matter of years, it will most likely attempt to return as much cash as it can to its shareholders. Such opportunities may not be feasible long-term investments, but can produce very favorable short-term returns, and are definitely worth investigating.
All in all, I think this is an amazing book that's backed by a lot of experience. There is a lot to take away given how short it is, and I personally know that it made me a more disciplined and vigilant investor. Definitely a must read for any investor.
September 2, 2020
A detailed footnote of Benjamin Graham's "The Intelligent Investor".
It went very detailed into:
- how to value companies broadly that can allow you to make quick decisions (instead of being paralysed by over analysis) at the same time won't be committing too much error in the event that your analyses are wrong
- what kind of undervalued investments should investor buy that might result in stellar returns (in the event that it succeeded) and at the same time won't lose you a lot of money (in the event it failed). For example: invest in liquidated companies.
And as usual like Benjamin Graham, the author spent many pages to remind people what is Margin of Safety and the importance of it. It might be banal and hoarse, but humans always forgot what is banal and hoarse.
It went very detailed into:
- how to value companies broadly that can allow you to make quick decisions (instead of being paralysed by over analysis) at the same time won't be committing too much error in the event that your analyses are wrong
- what kind of undervalued investments should investor buy that might result in stellar returns (in the event that it succeeded) and at the same time won't lose you a lot of money (in the event it failed). For example: invest in liquidated companies.
And as usual like Benjamin Graham, the author spent many pages to remind people what is Margin of Safety and the importance of it. It might be banal and hoarse, but humans always forgot what is banal and hoarse.
March 30, 2010
Geeking it out in the rain. Re-reading a book I bought randomly at The Strand and read in 1996 when I first started in the business. I guess there was only one printing in 1991, and now it's impossible to find and goes for over $1000 for a decent copy on Amazon or Ebay. Hmmm.... Is actually a great primer on how to think like a smart professional investor. Concepts aren't hard, but I don't imagine it would be all that interesting for the individual investor.
June 2, 2016
You probably won't find a hard copy as it is out of print and selling 2000 USD per copy. Seth Klarman is well known for keeping substantial amount of cash (>50%) in his portfolio when the he cannot find attractive opportunity. Nonetheless, excellent book which discuss the essence of Value investment: Margin of safety.
January 31, 2018
If I'd paid the going rate for a used, poor condition copy of over $1000, I would be disappointed. The book has some good information, albeit much of it out of date. I disagreed with a lot of his notions around speculation and think Buffet communicates these sentiments much more reasonably and convincingly.
June 4, 2014
Woke up regarding the meaning of Value. Very impactful book. Most important finding is that the value is outside S&P500, and probably at the top of the bottom-performers of the day, week, month.
August 9, 2019
skip the first 1/3, the rest is good to read
August 13, 2017
I find the book a little bit disorganized, I have summarized a few points below:
1. There is one crucial difference between investment and speculation:
Investments throw off cash flow for the benefit of the owners; speculations do not. They return to the owners of speculations depends exclusively on the vagaries of the resale market.
and this coincides with Buffett's view as well, as he once said:
So there’s two types of assets to buy. One is where the asset itself delivers a return to you, such as, you know, rental properties, stocks, a farm. And then there’s assets that you buy where you hope somebody else pays you more later on, but the asset itself doesn’t produce anything. And those are two different games. I regard the second game as speculation.
2. Do not let market price cloud your mind:
If you buy a stock that subsequently rises in price, it is easy to allow the positive feedback provided by Mr. Market to influence your judgment. You may start to believe that the security is worth more than you previously thought and refrain from selling, effectively placing the judgment of Mr. Market above your own. You may even decide to buy more shares of this stock, anticipating Mr. Market's future movements. As long as the price appears to be rising, you may choose to hold, perhaps even ignoring deteriorating business fundamentals or a diminution in underlying value.
Similarly, when the price of a stock declines after its initial purchase, most investors, somewhat naturally, become concerned. They start to worry that Mr. Market may know more than they do or that their original assessment was in error. It is easy to panic and sell at just the wrong time. Yet if the security were truly a bargain when it was purchased, the rational course of action would be to take advantage of this even better bargain and buy more.
3. Setting an investment goal of achieving a specific rate of return, say 15%, is of no good use. It's better to just follow a disciplined value approach in investing, because by doing so, good result will ensue:
An investor cannot decide to think harder or put in overtime in order to achieve a higher return. All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come. Targeting investment returns leads investors to focus on upside potential rather than on downside risk.
4. Always buy with margin of safety, remember that value investing is about avoid losing money:
Value investing is a risk-averse approach; attention is paid as much to what can go wrong (risk) as to what can go right (return).
The primary goal of value investors is to avoid losing money. Three elements of a value-investment strategy make achievement of that goal possible. A bottom-up approach, searching for low-risk bargains one at a time through fundamental analysis, is the surest way I know to avoid losing money. An absolute performance orientation is consistent with loss avoidance; a relative-performance orientation is not. Finally, paying careful attention to risk—the probability and amount of loss due to permanent value impairments— will help investors avoid losing money.
5. Should you worry when you've applied the margin of safety calculation to buy a security and find its price plunges further? No.
If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices. If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place.
6. That being said, when buying securities, you should always leave some room to average down:
In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve. Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline.
Evaluating your own willingness to average down can help you distinguish prospective investments from speculations.
A value investor may experience poor, even horrendous, performance compared with that of other investors or the market as a whole during prolonged periods of market overvaluation. Yet over the long run the value approach works so successfully that few, if any, advocates of the philosophy ever abandon it.
7. Identify the situations where stock prices tend to depart from underlying value for non-fundamental reasons:
There are numerous reasons, the forces of supply and demand do not necessarily correlate with value at any given time. Also, many buyers and sellers of securities are motivated by considerations other than underlying value and may be willing to buy or sell at very different prices than a value investor would. If a stock is part of a major market index, for example, there will be demand from index funds to buy it regardless of whether it is overpriced in relation to underlying value. Similarly, if a stock has recently risen on increasing volume, technical analysts might consider it attractive; by definition, underlying value would not be a part of their calculations. If a company has exhibited rapid recent growth, it may trade at a "growth" multiple, far higher than a value investor would pay. Conversely, a company that recently reported disappointing results might be dumped by investors who focused exclusively on earnings, depressing the price to a level considerably below underlying value. An investor unable to meet a margin call is in no position to hold out for full value; he or she is forced to sell at the prevailing market price.
The behavior of institutional investors, dictated by constraints on their behavior, can sometimes cause stock prices to depart from underlying value. Institutional selling of a lowpriced small-capitalization spinoff, for example, can cause a temporary supply-demand imbalance, resulting in a security becoming undervalued. If a company fails to declare an expected dividend, institutions restricted to owning only dividend-paying stocks may unload the shares. Bond funds allowed to own only investment-grade debt would dump their holdings of an issue immediately after it was downgraded below BBB by the rating agencies. Such phenomena as year-end tax selling and quarterly window dressing can also cause market inefficiencies, as value considerations are subordinated to other factors.
8. I have missed some good opportunities to make great fortune due to adherence to value investing and not following the herd and chasing the hot stocks, should I abandon value investing then?No.
True, conservatism may cause investors to refrain from making some investments that in hindsight would have been successful, but it will also prevent some sizable losses that would ensue from adopting less conservative business valuations.
the same view can be found in The Interpretation of Financial Statements
“The investor who buys securities only when the market price looks cheap on the basis of the company's statements, and sells them when they look high on this same basis, probably will not make spectacular profits. But, on the other hand, he will probably avoid equally spectacular and more frequent losses. He should have a better than average chance of obtaining satisfactory results. And this is the chief objective of intelligent investing."
9. To be really really conservative, should I make an investment only when I feel that I have learned all information about it? No, even if information is not 100% available to you (In fact, you can never learn 100% present information in any investment), you should consider the investment if it is truly a bargain with large margin of safety.
Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.
10. Catalyst is a perfect way to close the value gap and realize your profit so that it can be turned into cash again:
Value investors are always on the lookout for catalysts. While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market. Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value.
11. Maintain a good balance in portfolio liquidity. Do not be 100% invested in illiquid investments at any point in time. If you put money in illiquid investment, make sure the rewards are high enough to compensate your bearing of illiquid risks:
Since no investor is infallible and no investment is perfect, there is considerable merit in being able to change one's mind. If an investor purchases a liquid stock such as IBM because he thinks that a new product will be successful or because he expects the next quarter's results to be strong, he can change his mind by selling the stock at any time before the anticipated event, probably with minor financial consequences. An investor who buys a nontransferable limited partnership interest or stock in a nonpublic company, by contrast, is unable to change his mind at any price; he is effectively locked in. When investors do not demand compensation for bearing illiquidity, they almost always come to regret it.
Most of the time liquidity is not of great importance in managing a long-term-oriented investment portfolio. Few investors require a completely liquid portfolio that could be turned rapidly into cash. However, unexpected liquidity needs do occur. Because the opportunity cost of illiquidity is high, no investment portfolio should be completely illiquid either. Most portfolios should maintain a balance, opting for greater illiquidity when the market compensates investors well for bearing it.
This portfolio liquidity cycle serves two important purposes. First, as discussed in chapter 8, portfolio cash flow—the cash flowing into a portfolio—can reduce an investor's opportunity costs. Second, the periodic liquidation of parts of a portfolio has a cathartic effect. For the many investors who prefer to remain fully invested at all times, it is easy to become complacent, sinking or swimming with current holdings. "Dead wood" can accumulate and be neglected while losses build. By contrast, when the securities in a portfolio frequently turn into cash, the investor is constantly challenged to put that cash to work, seeking out the best values available.
1. There is one crucial difference between investment and speculation:
Investments throw off cash flow for the benefit of the owners; speculations do not. They return to the owners of speculations depends exclusively on the vagaries of the resale market.
and this coincides with Buffett's view as well, as he once said:
So there’s two types of assets to buy. One is where the asset itself delivers a return to you, such as, you know, rental properties, stocks, a farm. And then there’s assets that you buy where you hope somebody else pays you more later on, but the asset itself doesn’t produce anything. And those are two different games. I regard the second game as speculation.
2. Do not let market price cloud your mind:
If you buy a stock that subsequently rises in price, it is easy to allow the positive feedback provided by Mr. Market to influence your judgment. You may start to believe that the security is worth more than you previously thought and refrain from selling, effectively placing the judgment of Mr. Market above your own. You may even decide to buy more shares of this stock, anticipating Mr. Market's future movements. As long as the price appears to be rising, you may choose to hold, perhaps even ignoring deteriorating business fundamentals or a diminution in underlying value.
Similarly, when the price of a stock declines after its initial purchase, most investors, somewhat naturally, become concerned. They start to worry that Mr. Market may know more than they do or that their original assessment was in error. It is easy to panic and sell at just the wrong time. Yet if the security were truly a bargain when it was purchased, the rational course of action would be to take advantage of this even better bargain and buy more.
3. Setting an investment goal of achieving a specific rate of return, say 15%, is of no good use. It's better to just follow a disciplined value approach in investing, because by doing so, good result will ensue:
An investor cannot decide to think harder or put in overtime in order to achieve a higher return. All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come. Targeting investment returns leads investors to focus on upside potential rather than on downside risk.
4. Always buy with margin of safety, remember that value investing is about avoid losing money:
Value investing is a risk-averse approach; attention is paid as much to what can go wrong (risk) as to what can go right (return).
The primary goal of value investors is to avoid losing money. Three elements of a value-investment strategy make achievement of that goal possible. A bottom-up approach, searching for low-risk bargains one at a time through fundamental analysis, is the surest way I know to avoid losing money. An absolute performance orientation is consistent with loss avoidance; a relative-performance orientation is not. Finally, paying careful attention to risk—the probability and amount of loss due to permanent value impairments— will help investors avoid losing money.
5. Should you worry when you've applied the margin of safety calculation to buy a security and find its price plunges further? No.
If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices. If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place.
6. That being said, when buying securities, you should always leave some room to average down:
In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve. Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline.
Evaluating your own willingness to average down can help you distinguish prospective investments from speculations.
A value investor may experience poor, even horrendous, performance compared with that of other investors or the market as a whole during prolonged periods of market overvaluation. Yet over the long run the value approach works so successfully that few, if any, advocates of the philosophy ever abandon it.
7. Identify the situations where stock prices tend to depart from underlying value for non-fundamental reasons:
There are numerous reasons, the forces of supply and demand do not necessarily correlate with value at any given time. Also, many buyers and sellers of securities are motivated by considerations other than underlying value and may be willing to buy or sell at very different prices than a value investor would. If a stock is part of a major market index, for example, there will be demand from index funds to buy it regardless of whether it is overpriced in relation to underlying value. Similarly, if a stock has recently risen on increasing volume, technical analysts might consider it attractive; by definition, underlying value would not be a part of their calculations. If a company has exhibited rapid recent growth, it may trade at a "growth" multiple, far higher than a value investor would pay. Conversely, a company that recently reported disappointing results might be dumped by investors who focused exclusively on earnings, depressing the price to a level considerably below underlying value. An investor unable to meet a margin call is in no position to hold out for full value; he or she is forced to sell at the prevailing market price.
The behavior of institutional investors, dictated by constraints on their behavior, can sometimes cause stock prices to depart from underlying value. Institutional selling of a lowpriced small-capitalization spinoff, for example, can cause a temporary supply-demand imbalance, resulting in a security becoming undervalued. If a company fails to declare an expected dividend, institutions restricted to owning only dividend-paying stocks may unload the shares. Bond funds allowed to own only investment-grade debt would dump their holdings of an issue immediately after it was downgraded below BBB by the rating agencies. Such phenomena as year-end tax selling and quarterly window dressing can also cause market inefficiencies, as value considerations are subordinated to other factors.
8. I have missed some good opportunities to make great fortune due to adherence to value investing and not following the herd and chasing the hot stocks, should I abandon value investing then?No.
True, conservatism may cause investors to refrain from making some investments that in hindsight would have been successful, but it will also prevent some sizable losses that would ensue from adopting less conservative business valuations.
the same view can be found in The Interpretation of Financial Statements
“The investor who buys securities only when the market price looks cheap on the basis of the company's statements, and sells them when they look high on this same basis, probably will not make spectacular profits. But, on the other hand, he will probably avoid equally spectacular and more frequent losses. He should have a better than average chance of obtaining satisfactory results. And this is the chief objective of intelligent investing."
9. To be really really conservative, should I make an investment only when I feel that I have learned all information about it? No, even if information is not 100% available to you (In fact, you can never learn 100% present information in any investment), you should consider the investment if it is truly a bargain with large margin of safety.
Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.
10. Catalyst is a perfect way to close the value gap and realize your profit so that it can be turned into cash again:
Value investors are always on the lookout for catalysts. While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market. Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value.
11. Maintain a good balance in portfolio liquidity. Do not be 100% invested in illiquid investments at any point in time. If you put money in illiquid investment, make sure the rewards are high enough to compensate your bearing of illiquid risks:
Since no investor is infallible and no investment is perfect, there is considerable merit in being able to change one's mind. If an investor purchases a liquid stock such as IBM because he thinks that a new product will be successful or because he expects the next quarter's results to be strong, he can change his mind by selling the stock at any time before the anticipated event, probably with minor financial consequences. An investor who buys a nontransferable limited partnership interest or stock in a nonpublic company, by contrast, is unable to change his mind at any price; he is effectively locked in. When investors do not demand compensation for bearing illiquidity, they almost always come to regret it.
Most of the time liquidity is not of great importance in managing a long-term-oriented investment portfolio. Few investors require a completely liquid portfolio that could be turned rapidly into cash. However, unexpected liquidity needs do occur. Because the opportunity cost of illiquidity is high, no investment portfolio should be completely illiquid either. Most portfolios should maintain a balance, opting for greater illiquidity when the market compensates investors well for bearing it.
This portfolio liquidity cycle serves two important purposes. First, as discussed in chapter 8, portfolio cash flow—the cash flowing into a portfolio—can reduce an investor's opportunity costs. Second, the periodic liquidation of parts of a portfolio has a cathartic effect. For the many investors who prefer to remain fully invested at all times, it is easy to become complacent, sinking or swimming with current holdings. "Dead wood" can accumulate and be neglected while losses build. By contrast, when the securities in a portfolio frequently turn into cash, the investor is constantly challenged to put that cash to work, seeking out the best values available.
June 1, 2020
Seth Klarman is a great investor and speaker (as I have listened to him talk multiple times). However, this book was more an investment philosophy book as I did not take away any major insights. Good read though if you are starting out.
My notes on the book are below:
I. Where Most Investors Stumble
1. Speculators and Unsuccessful Investors
Investing is buying things that have cash flows, where as speculating is buying something you think you can sell later
Market fluctuations are caused by day to day differences in supply and demand
Those who invest with their emotions will fail in the long run
2. The Nature of Wall Street Works Against Investors
Wall street has a short term focus - as they make money on upfront commissions
3. The Institutional Performance Derby: The Client Is the Loser
Investment world has changed over the last few decades
From 1950-1990 - institutional share of market rose from 8% to 45% - by they think short term
They are rewarded on not what they return to clients but on percentage of their assets under management
Lagrer AUM makes it harder to generate returns
Rankings of firms frequently create short term motitacvtions
He thinks short term market fluctuations are random
4. Delusions of Value: The Myths and Misconceptions of Junk Bonds in the 1980s
Junk bonds was one investment fad
Difference between junk bonds from fall angle firms and bonds from fragile companies
Debt of angles is at discount to par - downside risk is reduced
New debt from eh companies does not share the discount and not the same
Interested how this fab was big even thought it was not tested but a economic downturn
II. A Value Investment Philosophy
5. Defining Your Investment Goals
Goal is to not “lose money” - Buffett quote
Hard to do as future is uncertian
So many factors go into stocks and they are uncertain in addition to having stock be the most junior instrument
Next chapters will discus how to help investors not lose money
6. Value Investing - The Importance of the Margin of Safety
Value investing is described as paying 50 cents for 1 dollar
Value investors can wait for the best investments to come
Margin of safety = buying at a discount
7. At the Root of a value investment philosophy
3 Central elements to value investment philosophy
A bottom up strategy
Absolute (opposed to relative) performance
A risk averse approach
Bottom up
Most investors are top down - in which they try to predict macro factors and then select investments
Too much room for error as the big picture needs to be correct
Also they are buying based on themes and trends - which has no value element
Bottom up allows investors to apply a margin of safety and face a limited number of questions - what is biz worth and what is downside
Absolute performance
Don’t judge based on performance to market
Instead focus on investment that are undervalued
Risk
Returns correlated with risk
Downside risk and upside potential are not the same thing
Investors look to investment with strong upsides and limited downsides
8. The Art of Business Valuation
Making a precise valuation is impossible
Should look at a range of assumptions
3 ways to value a business
NPV of cash flows - be conservative
Private market value - multiples approach on acquisitions
Business are not all equal
Liquidation value - fire sale vs liquidate over time
Failures of relying on EPS (can be manipulated), book value (not relevant to today’s value), and dividend yield (incentive by mgmt to make tiles appear attractive at expense of company’s future)
Book value - what something cost in the past is not a good indicator of value
Sometimes book value is similar to carrying value but sometimes not
Cash and AR are close to carrying value
PPE may be outdated and book may be less that carrying
Also company with a lot of write offs + a lot of deprecation may have a book value less than carrying
Real estate is based on historical cost
Book value may affect management decisions
Write offs
Share issuance and repurchase can affect book value
To be a useful tool this mesure needs to be consistent
Dividend yield
Used to be a measure of business prosperity
Should not be used now
Dividend firms stock drop increase yield
III. The Value Investment Process
9. Investment Research - The Challenge of Finding Attractive Research
Klarman finds it difficult to find investment opportunities
Important for investor to look in the right places
New low-lists and the largest percentage decliners lists
Dividends who have been cut or eliminated
Look at management to see what they are doing to the stock
Are they buying?
Find out why stock is doing poorly
10. Areas of Opportunity for Value Investors: Catalysts, Markets Inefficiencies and Institutional Constraints
Value investing examples in this chapter
Important to pay attention to business fundamentals (strong business at discounts)
Catalysts are good - ex: liquidation/ share buybacks/asset sales + shows management is interesting in returning value to shareholders
Can find value in special situations
11. Investing in Thrift Conversions
Explains opportunities in banking sector at the time
Banks were selling under book value
Besides the top 20 banks, people did not follow the other ones
12. Investing in Financially Distressed and Bankrupt Securities
Distress is more complex while normal is more unknown
Opportunities because most investors are unwilling to put in time
Financial distress occurs from
Operating issues
Legal issues
Financial issues
Firms can either do
Continue to pay obligations
Attempt to convert obligations
File chapter 11
People who know what to do have good opportunities with little risk
Analyzing distress firms starts with the balance sheet
Assets should be valued so you know the pie
Then subtract obligations
13. Portfolio Management and Trading
Value investors are not into buying certain industries or business ideas without regard to price
Always leave room to buy at cheaper prices
Klarman argues against selling after a percent gain or price target has been reached and instead should compare this investment to other investment opportunities
14. Investment Alternatives for the Individual Investor
Investing properly is a full time job and may be difficult for investors to manage their money
Options include
Mutual funds
Money managers
Open end mutual funds offer liquidity but are also huge and amy limit returns
Ask if the managers have their own money in the fund
Also size of fund and investment philosophy
Historical returns
My notes on the book are below:
I. Where Most Investors Stumble
1. Speculators and Unsuccessful Investors
Investing is buying things that have cash flows, where as speculating is buying something you think you can sell later
Market fluctuations are caused by day to day differences in supply and demand
Those who invest with their emotions will fail in the long run
2. The Nature of Wall Street Works Against Investors
Wall street has a short term focus - as they make money on upfront commissions
3. The Institutional Performance Derby: The Client Is the Loser
Investment world has changed over the last few decades
From 1950-1990 - institutional share of market rose from 8% to 45% - by they think short term
They are rewarded on not what they return to clients but on percentage of their assets under management
Lagrer AUM makes it harder to generate returns
Rankings of firms frequently create short term motitacvtions
He thinks short term market fluctuations are random
4. Delusions of Value: The Myths and Misconceptions of Junk Bonds in the 1980s
Junk bonds was one investment fad
Difference between junk bonds from fall angle firms and bonds from fragile companies
Debt of angles is at discount to par - downside risk is reduced
New debt from eh companies does not share the discount and not the same
Interested how this fab was big even thought it was not tested but a economic downturn
II. A Value Investment Philosophy
5. Defining Your Investment Goals
Goal is to not “lose money” - Buffett quote
Hard to do as future is uncertian
So many factors go into stocks and they are uncertain in addition to having stock be the most junior instrument
Next chapters will discus how to help investors not lose money
6. Value Investing - The Importance of the Margin of Safety
Value investing is described as paying 50 cents for 1 dollar
Value investors can wait for the best investments to come
Margin of safety = buying at a discount
7. At the Root of a value investment philosophy
3 Central elements to value investment philosophy
A bottom up strategy
Absolute (opposed to relative) performance
A risk averse approach
Bottom up
Most investors are top down - in which they try to predict macro factors and then select investments
Too much room for error as the big picture needs to be correct
Also they are buying based on themes and trends - which has no value element
Bottom up allows investors to apply a margin of safety and face a limited number of questions - what is biz worth and what is downside
Absolute performance
Don’t judge based on performance to market
Instead focus on investment that are undervalued
Risk
Returns correlated with risk
Downside risk and upside potential are not the same thing
Investors look to investment with strong upsides and limited downsides
8. The Art of Business Valuation
Making a precise valuation is impossible
Should look at a range of assumptions
3 ways to value a business
NPV of cash flows - be conservative
Private market value - multiples approach on acquisitions
Business are not all equal
Liquidation value - fire sale vs liquidate over time
Failures of relying on EPS (can be manipulated), book value (not relevant to today’s value), and dividend yield (incentive by mgmt to make tiles appear attractive at expense of company’s future)
Book value - what something cost in the past is not a good indicator of value
Sometimes book value is similar to carrying value but sometimes not
Cash and AR are close to carrying value
PPE may be outdated and book may be less that carrying
Also company with a lot of write offs + a lot of deprecation may have a book value less than carrying
Real estate is based on historical cost
Book value may affect management decisions
Write offs
Share issuance and repurchase can affect book value
To be a useful tool this mesure needs to be consistent
Dividend yield
Used to be a measure of business prosperity
Should not be used now
Dividend firms stock drop increase yield
III. The Value Investment Process
9. Investment Research - The Challenge of Finding Attractive Research
Klarman finds it difficult to find investment opportunities
Important for investor to look in the right places
New low-lists and the largest percentage decliners lists
Dividends who have been cut or eliminated
Look at management to see what they are doing to the stock
Are they buying?
Find out why stock is doing poorly
10. Areas of Opportunity for Value Investors: Catalysts, Markets Inefficiencies and Institutional Constraints
Value investing examples in this chapter
Important to pay attention to business fundamentals (strong business at discounts)
Catalysts are good - ex: liquidation/ share buybacks/asset sales + shows management is interesting in returning value to shareholders
Can find value in special situations
11. Investing in Thrift Conversions
Explains opportunities in banking sector at the time
Banks were selling under book value
Besides the top 20 banks, people did not follow the other ones
12. Investing in Financially Distressed and Bankrupt Securities
Distress is more complex while normal is more unknown
Opportunities because most investors are unwilling to put in time
Financial distress occurs from
Operating issues
Legal issues
Financial issues
Firms can either do
Continue to pay obligations
Attempt to convert obligations
File chapter 11
People who know what to do have good opportunities with little risk
Analyzing distress firms starts with the balance sheet
Assets should be valued so you know the pie
Then subtract obligations
13. Portfolio Management and Trading
Value investors are not into buying certain industries or business ideas without regard to price
Always leave room to buy at cheaper prices
Klarman argues against selling after a percent gain or price target has been reached and instead should compare this investment to other investment opportunities
14. Investment Alternatives for the Individual Investor
Investing properly is a full time job and may be difficult for investors to manage their money
Options include
Mutual funds
Money managers
Open end mutual funds offer liquidity but are also huge and amy limit returns
Ask if the managers have their own money in the fund
Also size of fund and investment philosophy
Historical returns
May 24, 2020
Though Margin of Safety is slightly more advanced than many other of its "investment classics" and perhaps not as applicable for a beginning investor (in Klarman's own words, it is "not a book about investing, but a book about thinking about investing"), it is probably one of the clearest manifestos for value investing. However, unlike the standard "cultish" value investment stuff you might find on the internet, it is mature and logical, without any sense of entitlement, and acutely aware of its own weaknesses.
Margin of Safety covers a couple of obscure (and technical) areas, such as spinoffs, distressed investing, and financial thrift conversions, but you don't have to understand all of what he says to be able to extract value from the book. I think it makes for a good followup to some of the more accessible pieces, like One Up On Wall Street or Joel Greenblatt's books.
Value investors, by contrast, have as a primary goal the preservation of their capital. It follows that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss.
Margin of Safety covers a couple of obscure (and technical) areas, such as spinoffs, distressed investing, and financial thrift conversions, but you don't have to understand all of what he says to be able to extract value from the book. I think it makes for a good followup to some of the more accessible pieces, like One Up On Wall Street or Joel Greenblatt's books.
May 25, 2021
Margin of Safety is a relatively modern alternative to Benjamin Graham's classic 'The Intelligent Investor' - that being said it is by no means up to date. However the careful reader will find precious nuggets of wisdom specially with regard to the internal workings of financial institutions and how they are not as efficient as they are made out to be. The book teaches us to be wary of investment bankers and analysts as both these groups suffer from a myopic worldview. Even institutional investors are not safe from biases - a reluctance to own small-cap stocks for example.
The book is divided into three parts - the first part focusses on areas where conventional wisdom fails, the second part on the value investment process, the third part focusses on investment opportunities - distressed companies, rights offerings etc. The third part is actually not that useful from an Indian standpoint but it was interesting none the less.
If I were to condense the message of the book into a few words it would be this - value investing by its very nature is contrarian and you have to be wrong for very long before you are right.
I liked how the book delivered its intended message but I would have preferred it if it were a bit more technical. Overall pretty solid book - worthy of a permanent position in the read and re-read list.
The book is divided into three parts - the first part focusses on areas where conventional wisdom fails, the second part on the value investment process, the third part focusses on investment opportunities - distressed companies, rights offerings etc. The third part is actually not that useful from an Indian standpoint but it was interesting none the less.
If I were to condense the message of the book into a few words it would be this - value investing by its very nature is contrarian and you have to be wrong for very long before you are right.
I liked how the book delivered its intended message but I would have preferred it if it were a bit more technical. Overall pretty solid book - worthy of a permanent position in the read and re-read list.
December 30, 2021
Took me a while, and I ended up reading it in small chunks at a time. It's considered a "cult hit", but fundamentally the ideas about value investing and the concept of margin of safety can be found in a ton of different resources nowadays. Yet it was interesting to read the original material, which is originally highly inspired by Benjamin Graham's The Intelligent Investor.
March 23, 2023
This book is the modern-day value investing Intelligent Investor. It's densely packed with tangible rules, lessons, and examples. In many aspects, it's superior to the red bible but requires more initial knowledge from the reader.
*Big thanks to Bart for his publishing efforts.
*Big thanks to Bart for his publishing efforts.
July 28, 2021
Magnifique.
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