3 Pieces of Investment Advice From Seth Klarman

Investing is a balance between arrogance and humility

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Jun 17, 2019
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As head of the Baupost Group, Seth Klarman (Trades, Portfolio) must have a pretty busy schedule. Despite this, he still finds time to educate the average retail investor. In an interview with Charlie Rose in 2011, Klarman hit on three important aspects of investing: market timing, balance of arrogance and humility, and what good management can add to a company.

Market timing

A lot of investors can recognize a bargain when they see one, but they are reticent to get involved in the stock because they think that it might go even lower. My old trading boss used to say that picking bottoms is a thankless task, and Klarman agreed:

“You can never tell how big a bargain you might get offered tomorrow. If someone comes along and wants to sell you a dollar for 50 cents, you can never know if they’ll want to sell it to you at 40 cents tomorrow, so you need to buy it and maybe leave a little room to buy more. And maybe someday spend your last dollar and buy the bargain, and maybe it goes down before it goes up.”

The real problem, according to Klarman, is not buying the absolute bottom -- it’s being sure that the stock actually is undervalued:

“The critical thing, the thing that would cause you to lose your confidence when you’re doing that would be if you realized a dollar wasn’t a dollar. You thought it was worth a dollar but Greece failed, or the euro fell or collapsed, and all of a sudden your dollar is only worth 30 cents and now what you thought was a bargain is overvalued. That’s the dilemma -- it’s not so much figuring out what it’s worth today, it’s making sure it’ll still be worth that same thing tomorrow.”

Investing is an act of arrogance

The most famous value investors like Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) are well known for their humility and introspection. But pulling the trigger on a big investment requires a certain amount of self-belief and arrogance too:

“You need to balance arrogance and humility. When you buy anything, it’s an arrogant act. You’re saying: ‘Markets are gyrating, somebody wants to sell this to me, and I know more than everybody else, so I’m gonna stand here and buy it. I’m going to pay an eighth more than the next guy wants to pay and buy it.' That’s arrogant. And you need the humility to say, 'But I might be wrong.' And you have to do that on everything.”

Squaring the circle of simultaneously exhibiting arrogance and humility is not easy. The best way to do it, in my view, is to not over-intellectualize your stockpicking, and to not become personally invested in your picks. Too many people are more concerned with looking right than making money.

On the value of good management

Management quality is a major component of value, but it can also be hard to quantify. Value traps are often created by poor, self-interested boards and executive suites:

“A lot of stocks are cheap for a reason, and often a value investor will figure out the reason is that everybody has gotten sick of a management overpaying themselves, deploying capital poorly, taking advantage of shareholders with free stock or huge options awards or hiring their brother-in-law. So there are stocks that have been perennially undervalued because they’re run by somebody that fits that profile.

A novice value investor will come along and say: 'Well, that looks awfully cheap.' And Graham and Dodd didn’t really place the quality of management as high as they might have. Good managements add value. Good managements have lots of levers that they can pull: They can buy back stock when it's undervalued. They can use the stock as currency when it’s overvalued. Bad managements will think only about themselves first.”

Disclosure: The author owns no stocks mentioned.

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