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Rupert Hargreaves
Rupert Hargreaves
Articles (1191)  | Author's Website |

Warren Buffett and Seth Klarman: Ignore Book Value Cost

Thoughts on intrinsic value from Klarman and Buffett

March 10, 2020 | About:

According to highly regarded value investor Seth Klarman (Trades, Portfolio), value investing gives investors something to hang on to in volatile markets. Like a lighthouse in a storm, value investors can look to intrinsic value as a marker of a company's worth, ignoring the Mr. Market's view of the business.

In times of market volatility, this advice is invaluable. Value investing is all about buying companies that are dealing at a significant discount to your estimate of intrinsic value. This discount is often referred to as the margin of safety.

Intrinsic value

It is all too easy to let the market dictate your actions when it starts falling. Research shows that humans feel losses more than profits, so wanting to cut your losses and run from a position is only human.

Concentrating on the price you paid for a security can compound this desire. Let's say you paid $1,000 for 100 shares in XYZ Corp. If the market drops 30%, and the stock follows suit, that investment is worth $700 today. After losing 30% in a short space of time, many investors might be persuaded to give up on XYZ Corp and invest elsewhere.

However, this is the wrong way of looking at the market, according to the Oracle of Omaha, Warren Buffett (Trades, Portfolio).

Forget book cost

Speaking at the Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual meeting of shareholders in 2009, Buffett advocated a different approach. Rather than concentrating on the value or the price paid for a particular security, he advised investors to use intrinsic value as a marker of value.

Specifically, when responding to a shareholder who asked Buffett for his views on whether to sell a basket of stocks if some of them "had doubled in a short time period," the CEO of Berkshire replied:

"We would own the half of dozen or so stocks we like best...it wouldn't have anything to do with what our cost on them was. It would only have to do with our evaluation of their price versus value. It doesn't make any difference what the cost is. And incidentally, if they went down 50%, we would say the same thing.
The cost basis doesn't have anything to do with the fund. When Charlie and I ran funds, we didn't worry about whether something was up or down. We worried about what it was worth compared to what it was selling for. And we tried to have most of our money in a relatively few — very few — positions which we thought we knew very well. We do the same thing now. We'd do the same thing a hundred years from now."

Buffett then handed the microphone over to his right-hand man, Charlie Munger (Trades, Portfolio), who summarised "he's tactfully suggesting that you adopt a different way of thinking."

Buffett's advice here is similar to that of Klarman. Both value investors concentrate on two things when they buy a security:

  1. Risk, defined as the risk of a permanent capital impairment
  2. Intrinsic value and the gap between price and value

If the intrinsic value of a security has not changed and its risk has not increased, then no matter what the market is telling them, these gurus will hold onto the position.

At the end of the day, a company is worth its intrinsic value. It is not worth the arbitrary value the market is placing on the stock at any point in time. Intrinsic value is what matters for value investors, and this does not change overnight.

In times of market uncertainty, investors should concentrate on value and ignore the noise from the rest of the market.

Disclosure: The author owns shares of Berkshire Hathaway.

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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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