IFB30: Quotes of Wisdom from Baupost Group’s Seth Klarman

Welcome to investing for Beginners podcast I’m David Ahern, and we have Andrew Sather here as well tonight. We’re going to do a review of an article that I came across from a blog that I read on a daily basis.

It’s called the Acquirers Multiple, and it is owned by a gentleman named Tobias Carlisle. He’s a very very amazing writer, and he’s written some great books. And he has this blog that he’s a member of that one of his authors that work for him writes some great articles.

The article that I came across I shared it with Andrew a couple of weeks ago, and we both liked it, and we thought this would be a great opportunity for us to talk a little bit about a gentleman named Seth Klarman.

We’ve talked about him a little bit in the past before, but this article that was written kind of outlines 13 tips on how to find bargains. Seth Klarman if you’re not familiar with him has written an amazing book on the margin of safety, and it’s unavailable more or less. You can buy an Amazon I believe for a cool thirteen hundred dollars a book if you wish.

Apparently, he did not release a lot of copies of the book and so it’s very very rare and hard to find I was fortunate enough to be able to find it. I read it through the professor of the local college had it, and the finance professor was kind enough to allow me to borrow it to read it. Andrew and I are going to kind of pick and choose through the tips that the gentleman shared in this article.

It’s a commentary from the collected wisdom of Seth Klarman, and it’s a compilation of quotes from the by Baupost Group founder Seth Klarman.

He writes an annual letter just as Warren Buffett does, but it’snot available to the public. It’s usually only available to his you know the people the insiders the people that invest in his fund.

What we will learn in today’s episode:

  • How to find a Margin of Safety
  • You need to do your research to find great companies
  • Be patient and wait for your pitch
  • Buy low and sell high, look for fear and greed in the market
  • Don’t try to time the market, look for your value and buy with a margin of safety

So I’m going to read a couple of the quotes and talk a few minutes about them and then Andrew is going to do the same. I also will link to the article in the show notes for this episode so that you will be able to find this article and read through them as you wish and find some things that you might like.

The first one that I came across that I liked was

“great investments don’t just knock on a door and say buy me.”

That is so true, and they do not just stand up and say hey here by me I’m cheap I’m going to make you tons and tons of money. It takes work to find great investments; there’s a lot of due diligence that you have to put into to be able to find a great investment.

You know Andrew, and I talked a lot about you know buying with a margin of safety, and this is a huge proponent of Seth Klarman’s investment philosophy, and there is a lot of effort that takes to go to find these bargains or these gems if you will. They’re not things that are readily available or that just kind of leap out at you.

A lot of times you have to look under a lot of rocks to try to find you know the one that you like and I think that’s a great quote and that struck me when I read the article that was one of the first things that kind of jumped out at me.

The next one that I liked was

“it’s easy to find middling opportunities but rare to find exceptional ones.”

Again this is a great quote that I think is very apropos for today with a market being at you know, of course, all-time highs seem like every single day. It’s hard to find great opportunities especially for value investors you know we’re always looking for great companies that we can find at a discount so that we can buy with a margin of safety with the emphasis on the safety. And trying to find exceptional companies that are on discount when the markets you know really at an all-time high.

It’s a challenge you know you have to screen and on a regular basis. You have to you know to use all the tools that you have available whether it’s the value trap blog or whether it’s you know the things that I try to do. You know there’s just so many avenues and ways that you can go to try to find opportunities. But finding something that’s exceptional, it’s not something you’re going to do every single day.

You think about the investors that Andrew and I talk a lot about that our you know mentors to us you know people like Seth Klarman, Warren Buffett, Charlie Munger, you know Peter Lynch.

Any of those guys you know they didn’t have you know their portfolios were not monstrously huge. You know we talked to a few weeks ago about Joel Greenblatt, and he did have a very large portfolio, but he’s more an exception to that to the rule than normal. You know Monish Pabrai, for example, I believe he has six or seven stocks in his portfolio right now.

Guy Spier, who another person I like he has you know maybe ten. You know Warren Buffett has a few, but he’s also been doing this for 50-plus years, so he’s had time to build up to a few of them. But the majority of his portfolio lies in a handful of stocks.

American Express, Wells Fargo among others so you know finding the great opportunities can be a challenge. And one of the things that Klarman talks a lot about in his book is when you find those exceptional ones is piling into them is going big on those because that where you’re going to make money. Is by finding the great ones and betting big on the ones that you know are going to be exceptional.

You know finding middling opportunities are going to make a couple more cents here, or there you know over the long term that’s not ideal. That’s not what we want to get because when you look at things that are involved in that such as fees. You know the time spent you know trying to find that opportunity and missing the other opportunity there’s an opportunity cost for those you know, so these two quotes that you know that I first read those are the first two that jumped out at me. Does Andrew you have a couple you wanted to share with us?

Andrew: I mean I guess if you’re going to twist my arm. I guess I could say something but you know I love those points obviously having tools like screener can be so crucial, and like you said it has to be something you seek out it’s not going to come, and this is this is one of those things it’s like entrepreneurship.

You know building wealth just in general it’s it’s like doing your fitness anything you want to try to improve on it’s something you have to seek out. You have to be proactive about, and you have to take the initiative and make things happen for yourself. And obviously, when you’re talking about opportunities that are you know especially on WallStreet and the stock market that undoubtedly is applicable.

This quote relates to that as well

“when buyers are numerous and sellers scarce opportunity is bound to be limited but when sellers are plentiful and highly motivated while potential buyers are reticent great investment opportunities tend to tend to surface.”

So it’s a fancy way and is a smart way of saying yeah you want to buy low and you want to sell high. You ‘re going to have a lot more opportunities when the market is pessimistic. You know when people are selling, and you know people are losing their jobs the economy’s not doing so well, and people just don’t want to be in the market.

That’s when you’re going to see the most opportunity, so I think it’s pretty obvious where Klarman stands when it comes to his investment philosophy. And it’s you see this theme parallel through a lot of the different fund managers that are now billionaires and have been able to amass such a huge net worth because of the way they have been able to buy securities for themselves and their shareholders. And it’s you got to be a contrarian you got to go against the grain you got to be able to stand up and understand that the crowds are not always going to be on your side.

You have to be not only okay with that table to see that and try to look for those kinds of opportunities and those kinds of situations so that you can get in and get the right kind of growth that you’re looking for from a performance perspective.

I liked that quote, and it’s again a very eloquent way of saying one of the most principle fundamentals of value investing is that you know like Buffett says you have to

“be greedy when people are fearful and be fearful when people are greedy.”

Dave: yeah that’s awesome that’s that’s one of my favorite Buffett quotes. I enjoy that yeah that that was a very fancy way of seeing buy low and sell high that perfect all right one of the ones that I liked as well.

“was you must buy on the way down there is far more volume on the way down then on the way back up and far competition among buyers it is almost always better to be too early than too late but you must be prepared for price markdowns on what you buy.”

You know one of the things that I liked about this quote that kind of struck me is you know investors tend to be a little bit more on the conservative side. I guess a good way of putting it and you know sometimes you get a little bit of the sky is falling.

Howard Marks who is one of my favorites, he releases memos every quarter. You know the last three or four memos that he’s released have all been fairly negative about the market and what not, and he’s been talking a lot about trying to get people to be prepared for a drawdown in the market.

You know when things go poorly, and people start selling, and you know this is when you can find great companies. And this is one of the things that you know value investors kind of look for when the market is getting hammered, and things are falling. That’s when you can find great opportunities and when a market is high like it is right now as we talked about before.

It can be difficult to find great opportunities, but when there’s, you know downturn in the market. That’s when you could find great opportunities, and you know Klarman was talking about it’s always better to be too early than too late.

You can never time the market I think this is what he’s talking about with this, and again this is a very eloquent way of saying you can’t time the market and you shouldn’t worry about wait until you can find the bottom because you don’t know when the bottom is going to be.

We’ve talked a lot about in the past about dollar cost averaging, and this is one of the things you can do to help that strategy. As themes you know going down if you find a company that you think is good you know if your dollar is cost averaging into that that can help mitigate some of that downturn.

The additional downturn in the market and you know he talked about you must be prepared for price markdowns on what you buy even if you do buy. Let’s say a stock starts off at the let’s just using these number a hundred dollars a share and then there’s a downturn in the market and all of a sudden it’s down to I don’t know sixty-two dollars.

You decide okay well I’m going to get into the company and then maybe it drips down again to maybe fifty dollars. Well, you could also buy it at the $50 as well, and then maybe it goes down another four or five dollars, and you can decide whether you want to buy it at that time or not. But as it goes back up if it will as it will if it’s you know the good company, and it’s just it’s only being brought down because the rest of the market is following suit then that’s where you can make your money.

I think that’s one of the things that I like about value investing is it gives you a strategy that you can use when things are going well. It also uses it gives you a strategy and when things are going poorly as well.

Andrew: yeah I love it kind of backpacking off of what I said previously. There’s quote here talking about a bargain price is necessary but not sufficient for investing because sometimes secure these I seem superficially inexpensive aren’t

while at the same time you want to find these bargains, and obviously, that’s the whole point of all these tips and everything we’ve been talking about. Value investing up to this point he also cautions that you know there can be a reason why these stocks are cheap, and you have to be able to identify the difference between a stock that’s cheap because it’s an opportunity a stock that’s cheap because it’s actually in trouble.

This why we have such a big focus when, I talk about my value trap indicator, and I talk about my research with the bankruptcies the idea of a value trap in the way that it can negatively affect your portfolio. Is something that you cannot overlook so understand that these bargains are going to show up in the market and it’s not so much seeing a bargain and taking it but it’s more so taking that next level and being able to say okay I see a bargain now I’m able to foresee.

How do you do this you use analysis you use fundamental analysis you dig into the annual reports, and you look at the numbers, and you understand what the ratios and the metrics are telling you? And you figure out what’s the big picture here with this stock you do all those things, and then you’re able to look at the bargain and perceive if it’s a bargain because if it adds a bargain and your chances of success are great. Or is it a bargain that seems superficially inexpensive as Klarman put it and isn’t.

So find out why stocks inexpensive and use that as a judgment call whether to pull the trigger or not.

Dave: I love it that’s so apropos you know one of my favorite quotes from WarrenBuffett was he said I like to buy stocks the same way I like to buy my socks on a bargain and I thought that was that’s awesome.

One of my favorite quotes from this little list was

rather than buy from smart, informed sellers we want to buy from urgent distressed or emotional sellers.”

And this to me harkens back to the discussion that Andrew and I just had about unconventional investing principles, and we talked a little bit about your emotions in that episode and how they control your thoughts and how they control what you want to choose to invest in.

Your thought processes behind that and as we’ve-talked about in other episodes when you buy or sell stocks based on emotion. That’s never a good thing, and we look for people that are going to be upset and that are making emotional choices. Because of you know as we all know when you make emotional choices you don’t always make rational choices.

You know the fear and the greed that we were talking about in the market when there’s a lot of fear in the market that is when we can find deals. That’s when we can find bargains, that’s we can find companies that are going to be selling a discount which gives us an opportunity to make a great investment.

Also, helps us with a margin of safety so if we do make a boo-boo and make a poor choice or make a bad decision we’re not going to get burned too badly on it.


Andrew: I think that was one quote that I liked and keeping on that theme of looking at the buy side of the equation looking at the price and the margin of safety here’s a quote here which says:

”typically we make money when we buy we count the profits later, but we know we have captured them when we buy the bargain.”

So this is obviously having confidence in the margin of safety or the intrinsic value you’ve calculated but the kind of key underlying idea here that he doesn’t say. But he implies is that not only are we going you know we talked about the principle dollar cost averaging, but here this is more like buying the whole type situation. So you have to look at investments over a long-term if you’re buying with an adequate margin of safety and you know that you’re getting a good deal you ‘re getting this bargain, and you’re buying it at less of what it’s worth.

Then even if the market doesn’t do, what you want it to do or that stock that you buy it doesn’t perform in the way you want you don’t take that to heart and you don’t see it as something negative and you don’t get discouraged and kind of sound just give up on the position.

Just because it isn’t going your way this is something you’re going to count the profits later you’re going to hold for a very long term and either you hold until it reaches that value that you know. It is, or you might even potentially and hopefully be holding it for even the longer timeframe.

You can be collecting dividends and seeing appreciate even past the intrinsic value that it was at before. So what Klarman is saying here is he has the confidence and the experience to understand that by buying with this margin of safety he’s already making that money and it’s just a matter of treating this investment just like all of his other investments. Understanding that the markets are going to go up and down, there’s going to be cycling of fear and greed, and now all you need to do is hold over the long term buy and hold your positions and things.

You will see the profits, but you do have to be patient you do have to stick it out, and you have to be intelligent and wise enough to understand this type of difference.

Dave: that’s such an awesome quote, man this guy’s a smart dude isn’t he just

Andrew: this yeah yeah he’s no wonder he’s a billionaire

Dave: yeah exactly right well the next one that I liked was

“These causes of mispricing are deep rooted in human behavior, and market structure unlikely to it be extinguished anytime soon.”

And this falls right into the ballpark of the latticework of mental models. This you know the mispricing you know it is so deep-rooted in our human behavior we’re always looking for something that is better than it is. And we’re willing to buy you know things because it’s cool or because we think it’s you know a great company, or we fall in love with something, and we’ll out buy regardless of whatever we think the price is.

We think about when we think about value investing it’s all about finding you the value it’s looking for what we think the company is worth. or a pair of jeans, how many times do you hear people talking about that they have to buy this pair of jeans because they’re the coolest thing ever. It doesn’t matter that they’re the same as the pair right next to them on the shelf that’s only ten bucks but these are one hundred and twenty-two dollars.

It’s human behavior that drives so much of pricing in the world and what we think we should buy and what we think we should want. And it comes down to that whether it’s need or a want and you know all that kind of stuff.

When we’re investing we’re looking to try to be rational and looking at numbers, we’re thinking about the value of the company as opposed to the price that the company that stock market is dictating to us. What we think the company worth and you know we you think about some of the companies out there right now.

I’m going to give you a couple of examples of Andrew, and I have talked about many times Amazon, Tesla, Snapchat, you know which by the way is getting hammered in the market right now because it’s not worth anything. And it’s overpriced, but people got super excited about it, and they bought into it because of an IPO, and it was shiny. And you know is that it was the new shiny thing and they got into it bought it. As you know, human behavior drove that it had nothing to do with the actual value of the company.

Marketers know this they play into our thoughts and our emotions and they figure out ways to, I hate to be so blunt manipulate us to do the things we want. And the same thing happens to the stock market.

A company comes out there, and the people that made money on that IPO for Snapchat, what bank that site of do you know that they would take this on to create an IPO for Snapchat and they marketed it, and they profited hugely from that company going from the public.

It’s just; it comes down to we have to be rational we have to keep our emotions in control we have to think about the decisions that we make and why we make the decisions, and we have to be aware of what we’re doing when we’re investing. Because you know it’s it’s a dangerous place, and if you make a big mistake you can lose big. And so you know being conservative you are now investing with a margin of safety the emphasis on safety that is such a huge you advantage for you when you walk into the market, and you want to buy something. And I think keeping your emotions and your behavior under control is so crucial.

Andrew: Yeah and this next level this is really deep, and I’m glad you covered. I think it’s a great way to end and it’s something we should all be processing even if you’re just hearing as you know as this kind of advice is coming by. But if you can internalize it I think it can take your investing to the next level.

Now I like if you haven’t read the book if there’s a way you can pick up Seth Klarman margin of safety offset I think it’s a fantastic resource. He does mention how much of Wall Street nowadays is filled with marketers much more so than it is filled with finance guys. Or guys who are trying to do well for their clients know they’re trying to attract funds, and we’ve talked about that before as well. So I think those are all things that you want to understand that not only is the market driven by humans and humans emotions and the weaknesses and faults and biases that all come along with that.

But it’s also very much influenced and fueled by money and the personal intentions, and you know there’s just a lot of conflicts of interest when you look on Wall Street, and you look at the way some of these companies and firms and people how they make their money. So it’s definitely can be difficult to navigate but educate yourself is so key when it comes to these type of things and if you can not only educate yourself on Wall Street on the market on how stocks work on how to analyze stocks on how to become a value investor.

But if you can take that next step and educate yourself about your self and what type of biases and emotions you’re going to be prone to falling under. I think it can do some great things and I think maybe that’s one of the things that separates a guy like Seth Klarman or Charlie Munger from the average Joe who never accumulates that kind of wealth.

Dave: I agree, that’s you know very well put well folks I think that’s going to go ahead and wrap it up for tonight.

I hope you enjoyed our discussion on Seth Klarman and some of the 13 tips that he’s created to help us find some bargains. I had a lot of fun talking about this, and I know Andrew did as well there was a lot of wisdom that could be found out there in reading. Whether it’s books or blogs or listening to Andrew and I talk there’s just a lot of wisdom out there and you know there are a lot of resources to help you become a better investor.

We want you to go out there and invest with a margin of safety the emphasis on the safety, and if you’re enjoying what we’re doing, we’d love to hear your thoughts. Give us some reviews on iTunes we’d love to hear.

Without any further ado, I’m going to go ahead and sign us off, you guys have a great week, and I’ll talk to you next week.

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