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Seth Klarman: Price is the essential determinant in every investment equation
05-05-2013, 10:51 AM.
Post: #1
Seth Klarman: Price is the essential determinant in every investment equation
Note: Seth Klarman is an american billionaire who founded the Baupost Group, a Boston-based private investment partnership. In 1991, Klarman authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.

--------------------------------
At the CFA Institute 2010 Annual Conference in Boston (held 16–19 May), Jason Zweig sat down with legendary investor Seth Klarman to gain insights into Mr. Klarman’s successful approach to investing.

Zweig: The first question I would like to ask you, Seth, concerns your work at Baupost. How have you followed Graham and Dodd, and how have you deviated from Graham and Dodd?

Klarman: In the spirit of Graham and Dodd, our firm began with an orientation toward value investing. When I think of Graham and Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind, their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from. It is easy to be persuaded that buying bargains is better than buying overpriced instruments.

The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything.

Where we may have deviated a bit from Graham and Dodd is, first of all, investing in the instruments that didn’t exist when Graham and Dodd were publishing their work. Today, some of the biggest bargains are in the hairiest, strangest situations, such as financial distress and litigation, and so we drive our approach that way, into areas that Graham and Dodd probably couldn’t have imagined.

The world is different now than it was in the era of Graham and Dodd. In their time, business was probably less competitive. Consultants and “experts” weren’t driving all businesses to focus on their business models and to maximize performance. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past.

Also, the financial books of a company may not be as reliable as they once were. Don’t trust the numbers. Always look behind them. Graham and Dodd provide a template for investing, but not exactly a detailed road map.

Zweig: Seth, you started your career at Mutual Shares, working for Max Heine and alongside Mike Price. Can you give us a couple of lessons you learned from those gentlemen?

Klarman: What I learned from Mike—and I worked most closely with him—was the importance of an endless drive to get information and seek value. I remember a specific instance when he found a mining stock that was inexpensive. He literally drew a detailed map—like an organization chart—of interlocking ownership and affiliates, many of which were also publicly traded. So, identifying one stock led him to a dozen other potential investments. To tirelessly pull threads is the lesson that I learned from Mike Price.

With Max Heine, I learned a bit of a different lesson. Max was a great analyst and a brilliant investor—and he was a very kind man. I was most taken with how he treated people. Whether you were the youngest analyst at the firm, as I was, or the receptionist or the head of settlements, he always had a smile and a kind word. He treated people as though they were really important, because to him they were.

Zweig: One of the striking lessons that came out of the global financial crisis of 2008 and 2009 is the way traditional value investors got slaughtered. What went wrong, and why did so many smart people get caught by surprise?

Klarman: Historically, there have been many periods in which value investing has underperformed. Value investing works over a long
period of time, outperforming the market by 1 or 2 percent a year, on average—a slender margin in a year, but not slender over the course of time, given the power of compounding. Therefore, it is not surprising that value could underperform in 2008 and 2009.

I would make two points. First, pre-2008, nearly all stocks had come to be valued, in a sense, on an invisible template of an LBO model. LBOs were so easy to do. Stocks were never allowed to get really cheap, because people would bid them up, thinking they could always sell them for 20 percent higher. It was, of course, not realistic that every business would find itself in an LBO situation, but nobody really thought much about that.

Certainly, many of the companies had some element of value to them, such as consumer brands or stable businesses, attributes that value investors might be attracted to. But when the model blew up and LBOs couldn’t be effected, the invisible template no longer made sense and stocks fell to their own level.

Second, because of the way the world had changed, it was no longer sufficient to assume that a bank’s return on book value would always be 12 or 15 percent a year. The reality was that instruments that were rated triple-A weren’t all the same. Watching home-building stocks may not have been the best clue to what was going on in the mortgage and housing markets.

Equity-minded investors probably needed to be more agile in 2007 and 2008 than they had ever needed to be before. An investor needed to put the pieces together, to recognize that a deteriorating subprime market could lead to problems in the rest of the housing market and, in turn, could blow up many financial institutions. If an investor was unable to anticipate that chain of events, then bank stocks looked cheap and got cheaper and earnings power was moot once the capital base was destroyed. That’s really what primarily drove the disaster.

------------------------------------
Read the complete interview on
.pdf   Seth-Klarman-CFA-Conference-2010.pdf (Size: 421.75 KB / Downloads: 72) . It is a bit long but there are many parts that worth reading

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05-05-2013, 01:11 PM.
Post: #2
RE: Seth Klarman: Price is the essential determinant in every investment equation
Great article is always great to share.
Thanks.

(05-05-2013, 10:51 AM)rogerwilco Wrote: Note: Seth Klarman is an american billionaire who founded the Baupost Group, a Boston-based private investment partnership. In 1991, Klarman authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.

--------------------------------
At the CFA Institute 2010 Annual Conference in Boston (held 16–19 May), Jason Zweig sat down with legendary investor Seth Klarman to gain insights into Mr. Klarman’s successful approach to investing.

Zweig: The first question I would like to ask you, Seth, concerns your work at Baupost. How have you followed Graham and Dodd, and how have you deviated from Graham and Dodd?

Klarman: In the spirit of Graham and Dodd, our firm began with an orientation toward value investing. When I think of Graham and Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind, their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from. It is easy to be persuaded that buying bargains is better than buying overpriced instruments.

The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything.

Where we may have deviated a bit from Graham and Dodd is, first of all, investing in the instruments that didn’t exist when Graham and Dodd were publishing their work. Today, some of the biggest bargains are in the hairiest, strangest situations, such as financial distress and litigation, and so we drive our approach that way, into areas that Graham and Dodd probably couldn’t have imagined.

The world is different now than it was in the era of Graham and Dodd. In their time, business was probably less competitive. Consultants and “experts” weren’t driving all businesses to focus on their business models and to maximize performance. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past.

Also, the financial books of a company may not be as reliable as they once were. Don’t trust the numbers. Always look behind them. Graham and Dodd provide a template for investing, but not exactly a detailed road map.

Zweig: Seth, you started your career at Mutual Shares, working for Max Heine and alongside Mike Price. Can you give us a couple of lessons you learned from those gentlemen?

Klarman: What I learned from Mike—and I worked most closely with him—was the importance of an endless drive to get information and seek value. I remember a specific instance when he found a mining stock that was inexpensive. He literally drew a detailed map—like an organization chart—of interlocking ownership and affiliates, many of which were also publicly traded. So, identifying one stock led him to a dozen other potential investments. To tirelessly pull threads is the lesson that I learned from Mike Price.

With Max Heine, I learned a bit of a different lesson. Max was a great analyst and a brilliant investor—and he was a very kind man. I was most taken with how he treated people. Whether you were the youngest analyst at the firm, as I was, or the receptionist or the head of settlements, he always had a smile and a kind word. He treated people as though they were really important, because to him they were.

Zweig: One of the striking lessons that came out of the global financial crisis of 2008 and 2009 is the way traditional value investors got slaughtered. What went wrong, and why did so many smart people get caught by surprise?

Klarman: Historically, there have been many periods in which value investing has underperformed. Value investing works over a long
period of time, outperforming the market by 1 or 2 percent a year, on average—a slender margin in a year, but not slender over the course of time, given the power of compounding. Therefore, it is not surprising that value could underperform in 2008 and 2009.

I would make two points. First, pre-2008, nearly all stocks had come to be valued, in a sense, on an invisible template of an LBO model. LBOs were so easy to do. Stocks were never allowed to get really cheap, because people would bid them up, thinking they could always sell them for 20 percent higher. It was, of course, not realistic that every business would find itself in an LBO situation, but nobody really thought much about that.

Certainly, many of the companies had some element of value to them, such as consumer brands or stable businesses, attributes that value investors might be attracted to. But when the model blew up and LBOs couldn’t be effected, the invisible template no longer made sense and stocks fell to their own level.

Second, because of the way the world had changed, it was no longer sufficient to assume that a bank’s return on book value would always be 12 or 15 percent a year. The reality was that instruments that were rated triple-A weren’t all the same. Watching home-building stocks may not have been the best clue to what was going on in the mortgage and housing markets.

Equity-minded investors probably needed to be more agile in 2007 and 2008 than they had ever needed to be before. An investor needed to put the pieces together, to recognize that a deteriorating subprime market could lead to problems in the rest of the housing market and, in turn, could blow up many financial institutions. If an investor was unable to anticipate that chain of events, then bank stocks looked cheap and got cheaper and earnings power was moot once the capital base was destroyed. That’s really what primarily drove the disaster.

------------------------------------
Read the complete interview on . It is a bit long but there are many parts that worth reading
=========== Signature ===========
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.

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05-05-2013, 04:34 PM.
Post: #3
RE: Seth Klarman: Price is the essential determinant in every investment equation
Several interesting Klarman's quotes from above interview:

Do not be pressured to be fully invested at all times

"Another issue that affected all investors, not just value investors, was the pressure to be fully invested at all times. When the markets are fairly ebullient, investors tend to hold the least objectionable securities rather than the truly significant bargains. But the inability to hold cash and the pressure to be fully invested at all times meant that when the plug was pulled out of the tub, all boats dropped as the water rushed down the drain."

"Our approach has always been to find compelling bargains. We are never fully invested if there is nothing great to do"

"Investors need to pick their poison: Either make more money when times are good and have a really ugly year every so often, or protect on the downside and don’t be at the party so long when things are good."

"We would rather underperform in a huge bull market than get clobbered in a really bad bear market."

About Indexing

"Tremendous disservice is perpetrated by the idea that stocks are for the long run, because you have to make sure you are around for the long run, that when you have unexpected pain, as many people did in 2008, you don’t get out and you actually are a buyer. The prevailing view has been that the market will earn a high rate of return if the holding period is long enough, but entry point is what really matters"

"I am much more inclined to buy a stock that has been kicked out of an index because then it may have value characteristics—it has underperformed."

About Gold

"Gold is unique because it has the age-old aspect of being viewed as a store of value. Nevertheless, it’s still a commodity and has no tangible value, and so I would say that gold is a speculation. But because of my fear about the potential debasing of paper money and about paper money not being a store of value, I want some exposure to gold."

About buying stock using market order

"Nobody should ever put in a market order. It doesn’t make sense because the market can change rapidly."

About making money

"we make money when we buy things. We count the profits later, but we know we have captured them when we buy the bargain."

About the definition of value company and average holding period

"With the exception of an arbitrage or a necessarily short-term investment, we enter every trade with the idea that we are going to hold to maturity in the case of a bond and for a really long time, potentially forever, in the case of a stock. Again, if you don’t do that, you are speculating and not investing. We may, however, turn over positions more often."

"In our view, there is no such thing as a value company. Price is the essential determinant in every investment equation. At some price, every company is a buy; at some price, every company is a hold; and at a still higher price, every company is a sell. We do not really recognize the concept of a value company."

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05-05-2013, 06:20 PM. (This post was last modified: 05-05-2013, 10:40 PM by Temperament.)
Post: #4
RE: Seth Klarman: Price is the essential determinant in every investment equation
Quote:"In our view, there is no such thing as a value company. Price is the essential determinant in every investment equation. At some price, every company is a buy; at some price, every company is a hold; and at a still higher price, every company is a sell. We do not really recognize the concept of a value company."
Sorry to say i believe the above very much. The problem is i am never sure about it when putting into practice.
So can anyone tell me how can we apply the above to "value investing"? Or how to relate it to value investing? Another words what is value? How to value? Or can make money is value?
=========== Signature ===========
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.

Find Reply
06-05-2013, 11:59 AM.
Post: #5
RE: Seth Klarman: Price is the essential determinant in every investment equation
Could be playing with words. In very layman terms, we used to say, "At this price, this is good value". Price and value are closely linked. But along the way, the lines between price and value gets drawn - "Price is what u pay, value is what u get" and ppl start to equate value with good. But even w good companies, there is still a reasonable and unreasonable
price.

Personally I lean towards the definition of value buys as cheaper than they ought to be. How much is then value is an art. When does value gets recognised and realised - dunno coz Mr Market does not share his thoughts v well. Still learning.
=========== Signature ===========
A stock well bought is half sold - Ben Graham
Price is the most important factor to use in relation to value - Walter Schloss

http://www.valuestocks.sg
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06-05-2013, 12:07 PM.
Post: #6
RE: Seth Klarman: Price is the essential determinant in every investment equation
My view is that if the Company is earning below its cost of capital and destroying shareholder value, would any price be justified to purchase it?

If you are purchasing based on a net-net analysis, where the liquidation value of the hard assets could yield a value higher than the share price, then perhaps there is a case for it.

But if the underlying argument is for profits or cash flow, then one may have to rethink that thesis.
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My Value Investing Blog: http://sgmusicwhiz.blogspot.com/

http://sgmusicwhiz.blogspot.com
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06-05-2013, 12:28 PM.
Post: #7
RE: Seth Klarman: Price is the essential determinant in every investment equation
Key is whether you get control of the company. This is a difference that many passive minorities fail to realise when they read comments of big money managers.
=========== Signature ===========
Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

Think Asset-Business-Structure (ABS)

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06-05-2013, 01:01 PM.
Post: #8
RE: Seth Klarman: Price is the essential determinant in every investment equation
Hi specuvestor,
Sorry, can you elaborate?
MW's definitions is quite a "classic one" . But yours a bit too much for me. How can passive minorities get control of the company? And that's the key?
=========== Signature ===========
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.

Find Reply
06-05-2013, 01:56 PM. (This post was last modified: 06-05-2013, 01:59 PM by specuvestor.)
Post: #9
RE: Seth Klarman: Price is the essential determinant in every investment equation
I'm actually not contradicting MW... I'm adding to what he says Smile

I'm saying the key difference between what Seth said and minorities is the control portion. The latter are usually passive and without control. OTOH the former could for eg buy distressed debt at huge discount and control the company. That's why for them price is the major determinant. They can REALISE the value of an asset by exerting control. This is markedly different from us... hence my caution that we have to read their literature with understanding of the circumstances.
=========== Signature ===========
Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

Think Asset-Business-Structure (ABS)

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06-05-2013, 02:05 PM.
Post: #10
RE: Seth Klarman: Price is the essential determinant in every investment equation
(06-05-2013, 01:56 PM)specuvestor Wrote: I'm actually not contradicting MW... I'm adding to what he says Smile

I'm saying the key difference between what Seth said and minorities is the control portion. The latter are usually passive and without control. OTOH the former could for eg buy distressed debt at huge discount and control the company. That's why for them price is the major determinant. They can REALISE the value of an asset by exerting control. This is markedly different from us... hence my caution that we have to read their literature with understanding of the circumstances.

Hmm..
You just remind me of WB.
Thanks.
=========== Signature ===========
WB:-

1) Rule # 1, do not lose money.
2) Rule # 2, refer to # 1.
3) Not until you can manage your emotions, you can manage your money.

Truism of Investments.
A) Buying a security is buying RISK not Return
B) You can control RISK (to a certain level, hopefully only.) But definitely not the outcome of the Return.

NB:-
My signature is meant for psychoing myself. No offence to anyone. i am trying not to lose money unnecessary anymore.

Find Reply


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