Seth Klarman (Trades, Portfolio) is one of the best value investors in the world alive and plying his trade today. Over the past two decades, Klarman has produced outstanding returns for investors at his hedge fund, Baupost.
With returns averaging around 20% per annum and in some years holding as much as 40% of assets under management in cash, Klarman has earned himself the reputation he has today.
Lesson from Klarman
It is always interesting to read Klarman's letters to investors. His thoughts on the market and value investing, in general, are invaluable and offer great insight into the way his mind works, and how he invests his investors' capital.
Thoughts and insights on value investing are exciting, but in my mind, they are not as interesting as his analyses on current and previous investments. It is often the case that these sections of his letters are only available to Baupost investors, and are kept secret. However, some insights have been dumped into the public eye.
In a letter to shareholders dated December 1999, Klarman detailed a range of Investments his fund was making at the time. What is especially interesting about these details is that Klarman was making the investments when the rest of the market was obsessed with internet stocks, yet he could find equities in more traditional industries changing hands for single-digit earnings multiples.
Spin-offs were proving to be a particularly lucrative area of interest for the value investor:
"We are also buying shares of the Tenneco Automotive spinoff; this company manufactures Monroe shock absorbers and Walker mufflers, and is the market share leader in nearly all of its products and markets. It currently trades at approximately four times after-tax earnings. It's shares have been particularly brutalized as a result of its deletion from the S&P 500 Index. Tenneco pre-spinoff traded at a market capitalization of several billion dollars; the highly leveraged Tenneco Automotive spinoff, still under extreme selling pressure, trades at a market capitalization barely above $200 million. Selling pressure has turned this market leader into a micro-capitalization stock, forcing many holders to exit because it no longer meets their size criteria."
Klarman and his team of analysts were also finding value in unloved segments of the market, or is he put it, "Small capitalization companies in mundane businesses:"
"Chargeurs is a French company which processes and trades in wool and produces fabrics, interlinings, and protective films. It is the market leader in virtually every segment in which it operates, generating substantial free cash flow from operations. Management is proactive in taking measures to maximize shareholder value including a securitization program to reduce volatility and risk in the trading business and the repurchase of a large number of shares. Some segments of the business have suffered as a result of the Asian crisis and are only now beginning to recover. Even on depressed results, however, the market values the company at approximately seven times earnings. Small capitalization companies in mundane businesses are out of favor in France, too."
And it was not only small mundane businesses that the rest of the market was avoiding. Klarman was finding value in real estate too, particularly, real estate-focused spin-off businesses with hard assets, that the rest of the market just did not seem to understand:
"We own several investments in the real estate area including shares in LNR Corporation, a spinoff a few years ago from a respected homebuilding company. This company is essentially an opportunistic investor in a variety of real estate assets, with a bias toward purchasing underperforming or out of favor properties, turning them around and selling them. They have achieved consistently strong returns over time, and the underlying value of the company's assets is close to twice the current market price of the shares. We expect underlying value to grow at a healthy rate for the foreseeable future. Management owns approximately 30% of the company's shares, and the company has been repurchasing substantial amounts of its own stock at the current price."
What immediately stands out about all these investments is that as well as being part of the "old world" the economy (or not tech stocks), they are all super cheap with management working to unlock value through share repurchases or other means -- value backed up with a catalyst.
With these securities in the portfolio, it is no surprise Baupost returned 22.4% in 2000 and over 14% in the first quarter of 2001 as the S&P 500 slumped.
Disclosure: The author owns no share mentioned.
