Notes Chapter 3: Margin of Safety

  • The great majority of institutional investors are plagued with a short-term, relative-performance orientation and lack the long-term perspective that retirement and endowment funds deserve.
  • [Taking about institutional investors] Hundreds of billions of other people’s hard-earned dollars are routinely whipped from investment to investment based on little or no in-deph research or analysis.
  • You probably would not choose to dine at a restaurant whose chef always ate elsewhere. You should be no more satisfied with a money manager who does not eat his or her own cooking.
  • Selling is difficult for money managers for three additional reasons:
    • 1) Many investments are illiquid, and disposing of institutional-sixed positions depends on more than simply the desire todo so.
    • 2) Selling creates additional work as sale proceeds must be reinvested in a subsequent purchase. Retaining current holdings is much easier.
    • 3) SEC, the governmental agency with regulatory responsibility for mutual funds, regards portfolio turnover unfavorably. Mutual fund managers thus have yet another reason to avoid selling
  • Institutional investors are caught in a vicious circle. The more money they manage, the more they earn. However, there are diseconomies of scale in the returns earned on increasingly large sums of money under management.
  • Allocating money into rigid categories simplifies investment decision making but only at the potential cost of lower returns.
  • Window dressing is the practice of making a portfolio look good for quarterly reporting purposes.
  • As depressed issues drop further in price, attractive opportunities may be created for value investors.
  • Unfortunately the appropriate relationship between bond yields and stock prices cannot be incorporated into a computer program. There are simply too many variables to allow investors to determine a relationship today that will apply under every future scenario.
  • Value investors believe that stock prices depart from underlying value and that investors can achieve above-market returns by buying undervalued securities.
  • Investing without understanding the behavior of institutional investors is like driving in a foreign land without a map.

Notes: Margin of Safety

Seth Klarman is one of the best-known value investor. He run a company called The Baupost Group for 33 years. In this list published last January the assets under management are $27 bn.

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I started his book, “Margin of Safety”, and I wanna to share my notes here, just to re-read it in the future.

Chapter 1: Speculators and Unseccessful Investors.

  • Stocks represent fractional ownership of underlying business and bonds are loans to those businesses.
  • Investors in a stock thus expect to profit in at least one of three possible ways:
    • From FCF generated by the underlying business, reflected in a higher share price or distributed as dividends.
    • From an increase in the multiple that investors are willing to pay for the underlying business as reflected in a higher share prices.
    • By a narrowing of the gap between share price and underlying business value.
  • Speculators, by contrast, buy and sell securities based on whether they believe those securities will next rise or fall in price. Many speculatores attempt to predict the market direction by using technical analysis as a guide.
  • Market participants do not wear badges that identify them as investors or specculators.
  • Value investors pay attention to financial reality in making their investment decisions. Speculators have no such thether.
  • Assets and securities can often be characterized as either investments or speculations. Difference: investments throw off cash flow for the benefit of the owners.
  • Successful investors tend to be unemotional, allowing the greed and fear of others to play into their hands. By having confidence in their own analysis and judment, they respond to market forces not with blind emotion but with calculated reason.
  • Two markets view: efficient markets and inefficient priced. The last one, create opportunities for investors to profit with low risk. Mr. Market by Benjamin Graham.
  • Sometimes Mr. Market sets prices at levels where you would neither want to buy nor sell. Frequently, however, he becomes irrational.
  • Value investors, who buy at discount from underlying value, are in a position to take advantege of Mr. Market´s irrationality.
  • The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value.
  • You cannot ignore the market but you must think for yourself and not allow the market to direct you.we
  • Unsuccessful investors: dominated by emotion.
  • There are countless examples of investor greed in recent financial history.
  • Given the complexitities of the investment process, it is perhaps natural for people to feel that only a formula could lead to investment success.