I looked on amazon at how much Margin of Safety costs, and the hardcopy version is selling for $7,453.31 in Canada. I could buy a used car for that money. Naturally, I obtained instead a digital copy at a much lower cost and read it, and have now given the summary notes on his views on investing in the stock market here. I probably don’t recommend paying that much for any book, regardless of how useful it is. Seth Klarman is the lead investor at Baupost Group since 1982, and according to Forbes he is a billionaire as of 2023. Let’s take a look at the timeless principles from his 1991 book.

-avoiding the mistakes made by others is a crucial stride toward attaining investment success. In fact, it almost guarantees it.

-Wall Street is a gigantic casino

-ETFs ignore business fundamentals and offer assured mediocrity

-make decisions based on business fundamentals

-investment success cannot be replicated in a mathematical equation or computer program

-value investors are worried about loss first, rather than reward, so they need a margin of safety

-in a rising market, growth investing is better

-in a stagnant or declining market, value investing is better

-value investing is either learned right away, or it is never learned, as Warren Buffett observed

Chapter 1 – where most investors stumble. Investing vs speculation.

-investors believe over the long run the stock price reflects the fundamentals of the business. And make money with: increased free cash flows, higher premiums, intrinsic value narrowing with stock price

-speculators love to guess where the market and stock prices are going. They love technical and chart analysis. They are primarily instant gratification people, with the crowd, and comfort in consensus. Most are speculators.

-Markets are not seen as speculative until much time has passed and much money lost

-when price goes up, people tend to want to own them (greed)

-Successful investors tend to be unemotional, and confident in own analysis and judgment. Responding with calculated reason not blind emotion. Conviction in panicking markets and caution in frothy markets

-security prices change in short term due to supply and demand. In the short term the market operates like a voting machine in the short term, but over time, it behaves more like a weighing machine

-Greed leads to investment to try and make a quick buck, laziness, undue optimism, complacency in the face of bad news

-Investing is NOT passive income

-buying low PE stocks does not work; they are low from depressed earnings

Chapter 2 – the nature of Wall Street works against investors

-Wall Street is trying to promote stocks in IPO so they are usually overpriced, and sometimes outrageously so; biased optimism for self-interest

-all mutual funds and many institutions are prohibited from selling short stocks or bonds

-financial market innovations are good for Wall Street but bad for clients

-invest in trends, not fads

-short selling can only occur if the last price move is up

Chapter 3 – the client is the loser

-people have gotten lazier and more irresponsible. In past generations, especially prior to World War 2, most individuals invested their own money. Now, most is by institutions. In fact, 3/4 of all or more of all money is estimated under institutional ownership.

-Running your own money management business is highly profitable in stocks, especially if you charge an annual fee; that is all profit.

-Thus, the goal is to keep clients in, not stand of with odd stock picks. Mediocre picks (same large caps as everyone else) are acceptable

-There are no winners in short-term, relatives’ performance derbies, only losers (except the brokerage firms)

-institutional investors do not even invest their own money along with client funds in the same stocks

-institutional investors rarely make unconventional investments; safe large caps, institutions are relative performance based

-as a true absolute return’s investor, we have to look at absolute fundamentals, and not always 100% invested

-many managers and people engage in window dressing

-stop losses are dumb because all they do is book small losses. Since market goes up usually, you just book in greater losses by buying back higher. Long and hold and that’s it. Along with selling futures in the same direction. That’s what caused Black Monday in 1987.

-Computers cannot make judgment calls in stocks, that’s up to the individual

-Index funds; mindless investing

-institutions and most index fund managers have no fundamental investment knowledge about the stocks they own

-investors who ignore institutional behaviour are likely to be periodically significantly trampled

-Significant opportunity lies in securities not looked at by institutions (small caps)

Chapter 4 – delusions of value, junk bonds in the 1980s

-scam: delay defaults (sell more than required money by firm), zero coupon bond, many academic research and articles writing positively about these junk bonds, even as they deteriorated, restructured, or defaulted

-an initial self-fulfilling prophecy that went ugly and destroyed instantly, per the bible in proverbs by 1990, after a boom in the 80s. Debt vs net tangible assets was 2:1, interest expense exceeded net income (interest coverage ratio went under 1). Accounting rules (no markdown) encouraged riskier bonds and higher yields more attractive to average investor. They were called thrift institutions back in the day.

interest rate reset bonds; the interest never reset in favour of gullible investors.

-avoid greater fool buys, unless you are very early

-business with low capital expenditures preferred. High cap ex only ok if it leads to a moat or industry with few competitors, thereby allowing the company to make way more sales, and only in a rising industry

-EBITDA obscured difference between good and bad businesses.

-companies with less cap ex will have more FCF over time which will command a higher valuation and this money can actually be returned to shareholders

Chapter 5 – defining your investment goals

-focus on risk, not return rates per year

Chapter 6 – Margin of safety

-it is fine to realize a loss if a better opportunity is present

-greedy investors who follow market trends and fads do not buy with a margin of safety

-stocks with high expectations priced in have the potential to skyrocket at any time

-companies that everyone follows tend to be fairly priced as many analyze it. Look for small caps with few analysts

Chapter 7 – value investment philosophy

-bottom up; focus on specific companies and forget about the macro

-do not focus on short term or relative performance, worry about long term performance

Chapter 8 – business valuation

-investors are overly optimistic about their own projections of stocks they picked

-financial markets have a self-fulfilling prophecy in that if the stock price is high, easier to raise more capital and stay in business. So, financial markets perception of a company influences the outcome.

-goodwill amortized as an expense over 40 years

-earnings and book value provided limit financial information to investors and should be used on a limited basis; subject to manipulations and choice of accounting. Instead focus on cashflow statement and cash flows (goodwill can be manipulated but not over a longer period of time)

-play within your circle of competence, or your strengths

Chapter 9 – investment research; challenge of finding attractive investments

-limited time and money; look in the right places to begin with to cut down on time spent searching

-arbitrage opportunities frequently listed on Wall Street journal and the New York Times business section

-year end tax selling for capital losses causes even more opportunity for investors

-by being contrarian and acting against the crowds, initially you get punished for it. However, over time it works out if the investment was right, if the herd was for another direction that actually influences the stock price from massive buying or selling

-investors seek certainty and all information. Yet, it often makes more money in uncertainty and when the investor doesn’t know everything, as that is when the price is lowest and the information is not yet materialized. If everyone knows it the price starts rising and the margin of safety from security of information disappears.

-an investment program does not succeed long term if high-quality research is not performed on a continuing basis

Chapter 10 – areas of inefficiencies

-need catalysts eventually; some only do some of the trick and some do more

-rights offerings are often an opportunity for investors, like warrants

-people sell from disappointment from prices not going higher fast enough. This causes a self-fulfilling prophecy on the fall instead of the rise side with panic selling. When something becomes a hot trade, everyone gets in setting the stage for a bubble

-Like Greenblatt, Klarman also mentions spin off shares are likely to trade at a depressed price initially, then skyrocket later. This makes them of particular interest to value investors.

Chapter 11

-although rare, thrift conversions with positive arithmetic are worth buying. Not common now

Chapter 13 – diversification is not about how many different things you own, but how different the things you do own are

-Investing is a full-time job; it cannot be done with long term success on a sporadic basis due to the complexity of analysis involved

Disclaimer

This is not Financial Advice. This article is meant only for educational and perhaps entertainment purposes.