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Rupert Hargreaves
Rupert Hargreaves
Articles (1299)  | Author's Website |

Seth Klarman's Core Investment Principles

A look at some of Klarman's advice over the years

January 21, 2020

Seth Klarman (Trades, Portfolio) is one of the greatest value investors alive today, and arguably one of the greatest value investors of all time. We can learn a lot from this fund manager's approach to investing.

Klarman believes that being a successful value investor requires more than just picking cheap stocks. For him, value investing is a lifestyle, and only a small number of people will ever be able to master the discipline and patience required to be successful over the long term.

Furthermore, the hedge fund manager also believes that value investors are the only investors that are successful in the market over the long term. Indeed, he once said:

"I've never seen people be successful over a long period of time without being value investors. To me, it's sort of like the E= MC2 of money and investing."

On another occasion, Klarman also described value investing as follows:

"Economics is important because you need to understand what assets or businesses are worth. Psychology is equally important because price is the critically important component of the investment equation that determines the amount of risk and return available from any investment. Price, of course, is defined in the financial markets varying with the vicissitudes of supply and demand for a given security."

Therefore, understanding both economics and the psychology of investing is critical if you want to become a successful value investor.

Investors who are looking for shortcuts to make the process easier are only going to be disappointed. Value investing is all about assessing the underlying intrinsic value of any particular security. There is no shortcut for this process.

Understanding intrinsic value requires research and general knowledge of the sector you are evaluating. It also requires basic accounting experience. Without any of these frameworks, it is almost impossible to build a model of intrinsic value. Simple ratios such as the price-earnings or price-book multiples are equally unreliable.

Because financial data is available for every financial market participant, trying to get an edge over the rest of the crowd using the same figures is difficult. With this being the case, Klarman recommends having an investment edge:

"If you are investing and you don't have an edge, you probably shouldn't be investing. And so we think about that a lot, that there are lots of really formidable competitors, a lot of money that's flowed into the hands of very capable value investors, long-term oriented, smart people. There are obviously also people that know a huge amount about industries, industry specialists, corporate executives, former executives, and so it's very competitive out there most of the time. So much of the time we have drifted into less liquid or more obscure parts of the universe."

With so much competition in the market, an edge is required to come out on top. There are a lot of brilliant people on Wall Street and in the market in general. As such, the market is actually quite efficient in the large and mega-cap space.

This is why Klarman and his team at Baupost often drift into the less liquid parts of the market. It is still possible to gain an edge in these parts of the market and outperform the rest of the crowd.

Disclosure: The author owns no share mentioned.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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