Street Journal, New York City. In the October publication of Financial Analysts Journal , Klarman offers his views on securities analysis work of Graham and Dodd. By that extension, this would include securities analysis by Warren Buffett:
The world is different now than it was in the eraKlarman is most definitively one of the few modern investors following Buffett who is "one-of-a-kind." Let us be realistic: although the teachings of Buffett are covered here, few readers are likely to be as successful as Buffett. This reality should not prevent investors from analyzing securities and the market diligently and thoroughly:
of Graham and Dodd. In their time, business was
probably less competitive. Consultants and
“experts” weren’t driving all businesses to focus on
their business models and to maximize performance.
The business climate is more volatile now.
The chance that you buy very cheap and that it will
Also, the financial books of a company may not
be as reliable as they once were. Don’t trust the
numbers. Always look behind them. Graham and
Dodd provide a template for investing, but not
exactly a detailed road map.
Our approach has always been to find compellingSo, what is Klarman buying?
bargains. We are never fully invested if there
is nothing great to do. We test all our assumptions
with sensitivity analysis. Through stress testing,
we gain a high degree of conviction that we are
right. We are prepared for things to go slightly
wrong because we adhere to a margin-of-safety
principle that gives us the necessary courage to go
against the tide.
Yet, we don’t actually think of it as courage, but
more as arrogance. In investing, whenever you act,
you are effectively saying, “I know more than the
market. I am going to buy when everybody else is
selling. I am going to sell when everybody else is
buying.” That is arrogant, and we always need to
temper it with the humility of knowing we could be
wrong—that things can change—and acknowledging
that we have a lot of smart competitors. Thus, in
worrying about all the things that can go wrong, you
can prepare, you can hedge—and you must remember
to sell fully priced securities so that you are
underexposed when things go badly. All these elements
give us the courage to follow our convictions.
The last point I would make is that your psychology
as an investor is always important. If you
lose your confidence, if you’ve made too many
mistakes, if you are down too much, it becomes
very easy to say, “I can’t stand being down more
than this.” Unless you have a bet-the-business
mentality, you would worry about your business,
about client redemptions, and about your own net
worth in the business.
So, by being conservative all the time—by
being both a highly disciplined buyer to ensure that
you hold bargains and a highly disciplined seller to
ensure that you don’t continue to own things at full
price—you will be in the right frame of mind.
Avoiding round trips and short-term devastation
enables you to be around for the long term.
Right now, we are buying, or trying to buy,About the stock market rally:
private commercial real estate because the stresses
in that market are creating bargains. The private
market in commercial real estate, especially the
private market for anything less than center city
Class A office or malls, has terrible fundamentals,
and the likelihood that they will get better soon is
not good. Yet the government has propped the
market up with TARP money and Public-Private
Investment Program money and also, essentially,
by winking at the banks. I think the Federal Deposit
Insurance Corporation has told banks, “Don’t be in
a hurry to sell your commercial real estate. We will
bear with you.” Servicers of commercial real estate
securities and mortgage securities have also been
slow to sell and eager to restructure.
In contrast to the private markets, the public
market in real estate has rallied enormously. Many
REITs are yielding 5 or 6 percent, which reflects
vastly higher prices and less attractive yields than
the private market offers.
Nevertheless, we are not making any money in
real estate right now. We are putting money to
work in private commercial real estate when we
can, very selectively, because those investments
will yield a good return over time, unlike the public
part of real estate that is quite unattractive.
We are making money on the distressed debt
we bought two years ago, which has gone from 40
or 50 or 60 to 90 or par, and on other similar securities
that have been grinding along, throwing off
cash, mostly rising in price or going through a
process that will ultimately deliver a profit to us.
Further reading as advised by Seth Klarman
- Graham’s The Intelligent Investor
- Graham and Dodd’s Security Analysis (6th ed with updated comments)
- Joel Greenblatt’s You Can Be a Stock Market Genius
- The Aggressive Conservative Investor,7 by Marty Whitman and Martin Shubik
- Anything from Jim Grant writes is wonderful
- Michael Lewis has never written a bad book
book about this era. It is about a microcosm, but the microcosm explains everything.
- Andrew Ross Sorkin’s Too Big to Fail is fabulous
- All of Roger Lowenstein’s books are excellent (we should read everything Roger has written)
Never stop reading. History doesn’t repeat, but it does rhyme.
Jim Grant has a wonderful expression: In science, progress is cumulative, and in finance, progress is cyclical. Fads will come and go, and people will think we are on to a new thing in finance or investing; but the reality is that it is probably not really new, and if we have seen the movie or read the book, maybe we know how it turns out.