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Rupert Hargreaves
Rupert Hargreaves
Articles (593)  | Author's Website |

What Makes a Value Investor According to Seth Klarman

Seth Klarman on the best qualities value investors possess.

April 16, 2018

I've recently been reading through a speech Seth Klarman (Trades, Portfolio) gave at the MIT Sloan Investment Management Club on Oct. 20, 2007. The speech concentrated on the best qualities a value investor must have to succeed and touched on some points about the current (2007) state of the financial system.

It's the comments on the value investor's personality that interest me. Here are some key takeaways from the lecture that I found particularly interesting.

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

Even though there are hundreds of different investors who have tried to describe value investing in different ways, I've never seen it described so succinctly as it is here. Understanding the value of a business is just part of the job of a value investor, it can even be argued that psychology is even more important if you want to achieve the best returns over time.

"It is crucial for investors to understand not only what value investing is, and that it works, but why it is a successful investment philosophy. At the very core of its success is the recurrent mispricing of securities in the marketplace. Value investing is, in effect, predicted on the proposition that the efficient market hypothesis is frequently wrong. If, on the one hand, securities can become undervalued or overvalued, which I believed to be incontrovertibly true, value investors will thrive. If, on the other hand, all securities at some future date become fairly and efficiently priced, value investors will have nothing to do. It is important, then, to consider whether or not the financial markets are efficient."

Value investors thrive because markets are not particularly efficient. This is a topic that is always up for debate, but I would argue that performance of standout investors just like Warren Buffett (Trades, Portfolio) and Seth Klarman (Trades, Portfolio) proves categorically that markets are not as efficient as some might believe. This is something Benjamin Graham has preached since 1934:

"As the father of value investing, Benjamin Graham, advised in 1934, smart investors look to the market not as a guide for what to do but as a creator of opportunity. The excessive exuberance and panic of others generates mispricings that can be exploited by those who are able to keep their wits about them. For three-quarters of a century, this advice has helped a great many value investors become very rich not quickly, but relentlessly, in good markets and bad."

If you are well aware of the unpredictability of markets and are prepared to use this to your advantage, taking advantage of weakness to buy and avoiding exuberance, then, over the long term, you should be able to outperform and become very wealthy in the process.

"The stock market is the story of human cycles and of the human behavior that is responsible for overreactions in both directions. Success in the market leads to excess, as bystanders are lured in by observing their friends and neighbors becoming rich, naysayers are trounced by zealous participants and as the effects of leverage reinforce early successes. Then, eventually, and perhaps after more time then contrarians would like, the worm turns, the last incremental buyer gets in, the last speculative dollar is borrowed and invested, and someone decides or is forced to sell. Things quickly work in reverse as leveraged investors receive margin calls and panicked investors dump their holdings regardless of price. Then, the wisdom of caution is once again evident, as not losing money becomes the watchword of the day."

Disclosure: The author owns no stock mentioned.

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.

Visit Rupert Hargreaves's Website


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