{"id":8242,"date":"2013-05-24T16:17:13","date_gmt":"2013-05-24T10:47:13","guid":{"rendered":"https:\/\/www.moneyworks4me.com\/investmentshastra\/?p=8242"},"modified":"2020-03-02T18:11:29","modified_gmt":"2020-03-02T12:41:29","slug":"margin-of-safety-by-seth-klarman","status":"publish","type":"post","link":"https:\/\/www.moneyworks4me.com\/investmentshastra\/margin-of-safety-by-seth-klarman\/","title":{"rendered":"Margin of Safety \u2013 by Seth Klarman"},"content":{"rendered":"
\n

A stock might be the right to own a piece of a business, and the intrinsic value of the stock was something you could estimate, but with a margin of safety, you can sleep at night.<\/em><\/strong>\u00a0– Warren Buffett<\/strong><\/em><\/p>\n<\/blockquote>\n

Have you ever wondered how investment decisions are made? Does \u2018Margin of Safety\u2019 ring any bell? Well, \u2018Margin of Safety\u2019, as experts say, is the key to value investing. If value investing is being discussed, Seth Klarman\u2019s name is bound to come into the picture. Seth Klarman is the author of the book \u201cMargin of Safety- Risk Averse Investing Strategies for the Thoughtful Investor\u201d, which is being touted as one of the best value investing classics ever since it was first published in 1991.<\/span><\/p>\n

In this book, he has compiled wise and timeless ideas on markets and science of investing. The \u2018Margin of Safety\u2019 in investment decisions provides a buffer between what investors pay for the stock and what they think it is worth, so that they are protected against unforeseen events or miscalculations.<\/span><\/p>\n

In his first and only book, Seth Klarman has described his investment philosophy in detail. The book is out of publication for over a decade now, but one can, sometimes, find it on eBay for around $1,000 since people regard it as a collectible.<\/p>\n

Seth Klarman is the chairman of Baupost Group, which is a Boston-based investment firm. He is considered to be one of the most successful value investors.<\/p>\n

The Baupost Group is one of the largest hedge funds in the world. It has consistently been one of the top performing hedge funds and, according to Bloomberg, L.P, is ranked fourth in net gains since inception.<\/p>\n

Klarman divides the book into three parts. The first part is about where investors make mistakes. In this part, the author starts by describing what speculators and unsuccessful investors do. He analyzes how price is important in determining the behavior of the market participants. In today\u2019s financial markets, the institutional investors are the dominant players and hence it is necessary to understand their behavior to understand the price fluctuations. An important reason to analyze the behavior of other investors and speculators is that their actions create opportunities for value investors.<\/p>\n

The market is a battleground where the investors must choose their sides carefully. The first choice \u2013 consists of majority of investors and speculators. Here the decisions are based on emotions of greed & fear and short-term performance. This is the wrong choice. The other side involves making decisions based on fundamental analysis. Not many people choose this side because it requires commitment and patience.<\/p>\n

According to Klarman, value investing is the only approach that will give positive results in the long term but with minimum risk<\/strong>.<\/span> Value investing<\/span><\/a><\/span><\/span> is not some kind of mystical art that can be practiced by only a selected few. On the contrary it is very simple. It only consists of determining the value of an underlying security and buying the security at a considerable discount from that value. The biggest challenge is to maintain the required patience and discipline to buy only when the prices are attractive and to sell when they are not irrespective of the market sentiments.<\/p>\n

However, investors \u2013 both individual and institutional \u2013 have often displayed their unwillingness to take long term investment decisions based on thorough fundamental analysis. The main reasons for this are the short-term performance pressures faced by the institutional fund managers and the frenzied atmosphere of the market.<\/p>\n

The second part of the book explains the underlying philosophy of value investing. Here, the author analyses why most of the investors are risk averse and what are its implications. At the core of the philosophy of value investing, is the concept of margin of safety.<\/strong> The three pillars of value investing are:<\/strong><\/span><\/p>\n