Seth Klarman’s “Margin of Safety” in one blog post

Margin of Safety, a value investing classic written in 1991, is out of print, sells for more than 2000$ and is one of the most stolen books in libraries. Here are some of my favorite quotes from Seth Klarman.

On Value Investing

“Value investing requires a great deal of hard work, unusually strict discipline, and a long term investment horizon”

“There is nothing esoteric about value investing, it is simply the process of determining the value underlying a security and then buying it at a considerable discount from that value. It is really that simple. The greatest challenge is maintaining the requisite patience and discipline to buy only when prices are attractive”

“If interplanetary visitors landed on Earth and examined the workings of our financial markets and the behavior of financial market participants, they would no doubt question the intelligence of the planet’s inhabitants. Wall street, the financial marketplace where capital is allocated worldwide, is in many ways just a gigantic casino.”

“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose. On the contrary, value investors have as a primarily goal the preservation of their capital. It follows that value investors seek a margin of safety, allowing room for imprecision, bad luck and errors. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others.”

“ I find value investing to be a stimulating, intellectually challenging, ever changing, and financially rewarding discipline”

Investing vs Speculating

“Investors in a stock expect to profit in at least one of three possible ways: from free cash flow generated by the business, which will be reflected in a higher share price or distributed as dividends, from an increase in the multiple that investors are willing to pay for the business or by a narrowing of the gap between share price and the underlying business value. Speculators, by contrast, buy and sell securities based on whether they believe those securities will next rise or fall in price. Their judgment regarding future price movements is based, not on fundamentals, but on a prediction of the behavior of others.”

“Some speculators look for Mr. Market for investment guidance. The reality is that Mr. Market knows nothing, being the product of the collectible action of thousands of buys and sellers who themselves are not always motivated by investment fundamentals.”

“Unsuccessful investors are dominated by emotions. Rather than responding coolly and rationally to market fluctuations, they respond emotionally with greed and fear.”


On Institutional Investors

“Like dogs chasing their own tails, most institutional investors have become locked into a short term, relative performance derby.”

“If the behavior of institutional investors weren’t so terrifying, it might actually be humorous. The prevalent mentality is consensus, groupthink. Acting with the crowd ensures an acceptable mediocrity; acting independently runs the risk of unacceptable underperformance.”

“The flexibility of institutional investors is frequently limited by a self imposed requirement to be fully invested at all times. Many institutions interpret their task as stock picking not market timing. They believe that their clients have made market timing decisions and pay them to fully invest all funds under their management.”

On Analysis

“The problem with intangible assets is that they hold no margin of safety. The most valuable assets of Dr Pepper/Seven up are the formulas that give those soft drinks their flavors. It is these intangible assets that cause Dr.Pepper/Seven up to be valued at high multiples of tangible book value. If something goes wrong tastes change or a competitor makes inroad the margin of safety is quite low. Tangible assets, by contrast, are more precisely valued and therefore provide investors with greater protection from loss. Tangible assets usually have value in alternate uses, thereby providing a margin of safety.”

“The top down investor thus faces the daunting task of predicting the unpredictable more accurately and faster than thousands of other bright people, all of them trying to do the same thing. It is not clear whether top down investing is a greater fool game, in which you win only when someone else overpays, or a greater genius game, winnable at best only by those few who regularly possess superior insight. In either case, it is not an attractive game for risk averse investors. There is no safety of margin in top down investing. It is not even clear whether top down oriented buyers are investors or speculators. “

Risk and Return

“Greater risk does not guarantee greater return. To the contrary, risk erodes return by causing losses. It is only when investors shun high risk investments, thereby depressing their prices, that an incremental return can be earned which more than fully compensates for the risk incurred. By itself risk does not create incremental return; only price can accomplish that.”

“Investors must be willing to forego some near term return, if necessary, as an insurance premium against unexpected and unpredictable adversity”

“All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come”

The Fallacy of Indexing

“To value investors the concept of indexing is at best silly and at worst quite hazardous. Warren Buffett has observed that “in any sort of a contest — financial, mental or physical — it’s an enormous advantage to have opponents who have been taught that it’s useless to even try.” I believe that over time value investors will outperform the market and that choosing to match it is both lazy and shortsighted.”

“Indexing is a dangerously flawed strategy for several reasons. First, it becomes self-defeating when more and more investors adopt it. Although indexing is predicated on efficient markets, the higher the percentage of all investors who index, the more inefficient the markets become as fewer and fewer investors would be performing research and fundamental analysis.”

On Price Fluctuations

“In addition to the probability of permanent loss attached to an investment, there is also the possibility of interim price fluctuations that are unrelated to underlying value.”

“Many investors consider price fluctuations to be a significant risk: if the price goes down, the investment is seen as risky regardless of the fundamentals. But are temporary price fluctuations really a risk? Not in the way that permanent value impairments are and then only for certain investors in specific situations.”

“It is, of course, not always easy for investors to distinguish temporary price volatility, related to the short-term forces of supply and demand, from price movements related to business fundamentals. The reality may only become apparent after the fact.”

“While investors should obviously try to avoid overpaying for investments or buying into businesses that subsequently decline in value due to deteriorating results, it is not possible to avoid random short-term market volatility. Indeed, investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate some volatility.”

“If you are buying sound value at a discount, do short-term price fluctuations matter? In the long run they do not matter much; value will ultimately be reflected in the price of a security. Indeed, ironically, the long-term investment implication of price fluctuations is in the opposite direction from the near-term market impact.”

Dear reader, if you get your hands on an original copy, hide it well. It might be worth a lot more in a decade.

Georges Boustany


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One response to “Seth Klarman’s “Margin of Safety” in one blog post”

  1. . says :

    I ve been trying to read his quarterly reports for years can’t find them anywhere. Any idea where we can read them?
    Thank you

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