Customer Reviews

Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor

5 star:		(16)
4 star:		(7)
3 star:		(2)
2 star:		(4)
1 star:		(4)

 

 

This book is one of the hardest finance books to track down today. Published in 1991, it is now out of print, and sells on Amazon and Ebay for over $1000. It is even one of the most-stolen library books, making it very difficult to find a copy to read.

Seth Klarman, the portfolio manager of The Baupost Group, is a very successful practitioner of the value investing strategy. In this book, he sets out to educate the reader on this concept, stressing the advantages of a risk-averse approach. In his introduction, Klarman states that even if this book, as a side effect of educating more people to invest in a more sophisticated manner, causes diminished returns to himself - he considers it well worth it for the public good. While I highly applaud this mentality, it begs the question: why was the book not published again? Considering what I mentioned in the first paragraph, clearly there is significant demand to read it. Anyway, on to the book itself...

"Margin of Safety" is divided into three portions. The first part discusses where most investors make mistakes and stumble - it covers investing vs. speculation, the nature of Wall Street, and how institutional investing results in a short-term performance derby (of which the client is ultimately the loser). It also encapsulates the presented information in a thoughful case study of junk bonds in the 1980s. The second portion of the book introduces the details of the value-investment philosophy, primarily focusing on risk and how it is crucial to invest with a margin of safety. The last part provides useful applicable advice on actually following the value-investment process: where to find investment opportunities, how to invest in these opportunities, and various aspects of overall portfolio management.

Simply put, the book is fantastic. Klarman writes in an amazingly clear manner. His language is neither too simplistic nor overly difficult - just right. I definitely experienced a "wow" feeling when I began reading, after the finance books I have read recently. In addition, Klarman provides a myriad of examples to illustrate the points he brings up, which is very helpful, because it puts a reality spin on his writings.

Don't, however, mistake "clear writing" for "easy content." While the book is clear, precise, and very straight-to-the-point (i.e. there is no useless fluff frequently found in books advocating certain investment approaches), Klarman's content is not trivial. The first and even the second portions of the book are relatively quick and simple - after all, the material presented (a discussion of various common investor mistakes, followed by the basic explanation of value investing) is not overly difficult. The third and last portion of the book, however, is very dense: a lot of information is presented quickly. I actually found myself having to re-read a few of the later chapters multiple times, making sure I understand what Klarman was trying to illustrate. I took notes while reading, so that helped absorb the material - but it still wasn't easy.

This brings me to the only personal gripe I had with the book. There were multiple instances in the later chapters where I wished that Klarman would elaborate more on some of his statements and examples (for instance, calculating NPV for certain businesses, more discussion on thrift institutions, etc.). The author certainly assumes some previous experience, as some of his non-basic explanations are clearly not geared for outright beginners. There was never a point, however, where I felt completely out of the loop. I had to read some portions over again and even look up additional information on the web, but in the end Klarman's words always made sense.

This book is absolutely the best overview of value investing I have ever read or heard. Klarman stresses the importance of carefully evaluating risk (as we often only focus on return) and investing with a margin of safety. He repeats this main point over and over again throughout the entire book. Amazingly, it doesn't feel overly repetitive - but instead, a constant timely reminder of the ideas behind the value investing process. A major theme in the book is that we can't predict the future, and hence we must always be ready for anything - and the only way to do this is to protect our investments with a sufficient margin of safety (essentially investing in a security at a significant discount to underlying value).

Aside from a clear explanation of his investing philosophy, Klarman provides tons and tons of useful practical advice, from how to valuate businesses (he makes sure to distinguish his preferred methods from other widespread strategies) to where to find excellent investment opportunities for value investors. He devotes multiple chapters to discussing the frequently neglected portions of the market where low-risk and potentially high-return investments can be made. In the last two chapters, Klarman takes a step back from discussing individual investments and focuses on overall portfolio management and various alternatives for the individual investor.

One may wonder how applicable some of the specific advice is today. Are thrift conversions really still good places to find hidden value? Maybe not. Is manually calculating the cash flow of a business through the faulty measure of EBITDA still a problem today? Not really, since cash flow statements are now part of the required financial statements for public companies. But a lot of Klarman's essential advice (do your analysis carefully - look behind the numbers) and much of his presented "fertile ground for opportunities" still applies and exists today. Furthermore, the wonderful thing about value investing is that it is contrarian in its nature - which essentially implies that, as investments in various portions of the market come in cycles, a value investor can patiently wait for a popular area to "overflow", collapse, and offer excellent opportunities to invest while the herds of investors shy away and sell out. So even if some of Klarman's hunting grounds may seem outdated right now, they will again be attractive in the future.

One thing to note is that each chapter contains a set of footnotes. I advise the reader not to ignore these - they sometimes contain interesting examples and valuable advice. Unfortunately, they are easy to skip, as they're not printed at the bottom of the page which references the footnote, but rather at the back of each chapter.

In conclusion, I highly recommend Klarman's book to... anyone, really! Seasoned veterans will undoubtedly find excellent insight into things that may have before seemed ordinary and trivial. Beginners will learn fantastic advice that may help steer them away from poor decisions made by many inexperienced investors today. I personally don't think it is worth paying the market price for the book today just to read it (although many may argue that even the going price is at a huge discount from the underlying value) - but I suggest trying to obtain the book through an Inter-Library Loan. It may take some time and effort to find a copy, but it's well worth it.

Pros:
+ clear and concise writing, no fluff
+ lots and lots of illustrative examples
+ very clear explanation of the basic concept of value investing and a margin of safety
+ useful methods for researching and valuating a business
+ tremendous amount of applicable advice on finding and analyzing investment opportunities
+ lots of other real-world advice on various topics from portfolio management to money manager selection

Cons:
- last portion of the book is dense, may require careful reading and re-reading
- a small portion of the material may be slightly out of date (don't let this deter you)

When I first heard about this book, being a novice yet avid investor, I was very enthusiastic to get my hands on it. My friends and I went on a scavenger hunt to every public and university library that might have had it. When we finally found it, we were definitely excited because we thought, "Why would this book be valued so highly, if it didn't have very good insights on how to beat the market and gain above average returns?"
Needless to say it was an average book on value investing. And I stress average. If you're going to spend anything over $100 for this book, don't. If you still need to read it, get it from a library, but you'll still see that it probably wasn't worth it. All the clout that this book gets from being so pricey doesn't merit either trying to find it, or paying the price.
That being said, the author didn't have enough real life examples. He talked about a few companies that he realized significant gains on, but the intricacy of how he did it is not really discussed at length like Peter Lynch does in his books.
All in all, don't waste your money, and read one of the more popular Lynch or Graham books on value investing which are better written and more detailed.

Few people outside the value investment arena know who the author is, but take my word for it: he's an investment superstar. Seth runs a private investment firm in Cambridge, MA called the Baupost Group, and isn't soliciting your money! Klarman is on par with Buffett, Ruane & Cuniff, et. al. His book is a MUST read for it's intelligent, frank discussion of intrinsic value investing. Don't look for this book if you're long E-Bay right now. You can probably find the book in a large library, I would look for it if you already found your way to this review!

This book review is different. I liked this book a lot, but I don't want you to buy it. Why? I'm a value investor, that's why. More on that in a moment.

What commends this book to our attention? It is a well-written book on value investing by one of its leading practicioners, Seth Klarman. I love reading books on value investing written by the experts who have done it so well. It is useful to get their differential insights. It sharpens you.

What I found in Margin of Safety was a very good basic book on value investing. It contains the usual warnings against speculation, which most retail investors do, and how Wall Street frequently overcharges and misleads retail investors. Even institutional investors get cheated by focusing on relative performance, rather than absolute performance, according to Mr. Klarman. As an absolute value investor, he wants to make money all the time, not just beat the market. (A word here, if stocks beat safe bond investments on average, then there may be some validity to relative value investing.)

The book was written in 1991, after the junk bond market collapse, and contains a decent amount of criticism of the era. Buying high yields is not enough, those yields be realizable from companies that can produce cash flows to support the price of the bonds.

The book also reflects the author's early career in the investment shop founded by Max Heine, and run by Michael Price, until it was sold to Franklin Resources. The Mutual Series Funds did ordinary value investing, but they also bought special situations, did deal arbitrage, bought distressed debt, and more.

The eponymous and key idea of the book is Ben Graham's concept of a margin of safety. Invest in assets where your likelihood and severity of loss is low, given your purchase price. Don't take risks unless you are handsomely paid to take them. If you buy enough of them cheap enough, you will do well in the long run.

All in all, a very good book on value investing. Why not buy it? Too expensive. The book is good, but very basic. You can do better for free with:

* Warren Buffett's stockholder letters.
* Marty Whitman's shareholder letters.
* And others...

So how much would it cost to buy a copy? $900-$2000. You can see the results at Ebay and Amazon. Put on your cost-sensitive sunglasses before viewing.

It's a very good book, but relative to what is available for free or at nominal (<$30) cost, it doesn't make sense to buy it, aside from bragging rights.

So, how did I end up with a copy? I don't have a copy. I borrowed it via Interlibrary loan and quickly read it, sending it back to the nice library in Florida that lent it to my library. I recommend that you do that as well, if you want to read the book. If you are game, I also ask that you write Seth Klarman at:

THE BAUPOST GROUP
10 St. James Avenue - Suite 1700
Boston, MA 02116

617.210.8300

Write a nice letter, asking him to do a second edition of the paperback version for a new generation of young value investors.

First, let me say that I've only actually seen a physical copy of this book once. I did have an opportunity to read it when a stained, paper-clipped pile of 15th or 20th generation photocopied pages comprising the entire book made the rounds at my office. Since that time, a PDF has circulated online and now, the content is freely available, effectively quashing any 'utilitarian' arguments for buying it.

The content is impressive, somewhat unique and very incisive, however, I think that in the year 2008, with copies of this book selling for $1500+, Margin Of Safety is now only 50% "book" with the remaining 50% being folklore and mythology. Owning a physical copy of MOS has become like a $25,000 wristwatch for value investors. It isn't about telling time... It's about how much you spent and showing the world what you have... and yes, you will find that the "value investors" who spent four figures for a copy of this book will defend their prize purchase to their dying breaths.

That Klarman has never ordered a reprint of this book tells us that he probably regrets having published it in the first place, not because it's a bad book but quite to the contrary, because it's a very good book that outlines much of his game plan; the profitability of which is greater the fewer competitors he has practicing it along with him.

Having finally "proven" everything he wrote in MOS with the Buffett'esque performance of his Baupost Group, I would wager that if he could go back in time and 'unpublish' this book, he probably would.

Still, would I ever pay this kind of money for a copy?
Heck no. Of course, I won't buy a $10,000 wristwatch, either.

I come to know about this book from the recommended booklist of Greenblatt's "You Can Be a Stock Market Genius". Indeed, I found that most of Greenblatt's ideas may actually originate from this book.

The author gave a strong case for value investing. And, I think if one really follows Seth's way of value investing, investment success is close to a sure thing. By reading the investment examples in the book, I understand how strict requirements Seth has for an investment to be considered worth investing.

I think the idea is that

1. If you dont understand it, pass it;
2. If you do understand it but the price is too high, pass it;
3. If you do understand it and the price is really low, take it.

All in all, I would agree with another reviewer that this book is worth its weight in gold.

P.S. The other two investment books I'd recommend are:

1. The Aggressive Conservative Investor by Martin Whitman
2. You Can Be a Stock Market Genius by Greenblatt

Although I wouldn't spend $1000 for this book, he surprised me by summing up in a few simple sentences...

- how the mortgage tranched CDOs are flawed,
- how the rating agencies are claiming it was unforseeable, and
- how it could all blow up by a credit crunch.

But the most amazing part was that he did this in 1991 (when the book was published) and that is way before the mortgage CDOs were in full swing.

I just wish I had read the book earlier.

Bottom line: Klarman wrote a solid book on value investing that is worth reading, IF you can find it in your library for free or pick it up for $20. IT IS NOT WORTH HUNDREDS OF DOLLARS.

This book does NOT contain any secrets that will give you an investing edge (which is the reason I would assume the price is so high - right?). You can learn the same things from the more reasonably priced value investing books on the market. I would suggest to use the hundreds you would spend on this for dozens of other books, maybe a journal subscription, or invest the money (probably the best idea). It's a real shame they haven't republished this book though, because like I said, it's worth normal book prices (i.e. $20 bucks or so).

To give a little more insight into the book, Klarman has written a similar book as The Intelligent Investor. He starts by discussing the difference between speculators and investors, then the mental framework one must have to properly apply value investing, the general investing philosophy, and then going into the investment process. Due to it's length of 243 pages, it is not a textbook on the material. It is a great introductory to amateur read for value investing, though even professionals may enjoy the read and even take something away from it. But if you're thinking about reading this and have not read The Intelligent Investor, go read that instead and forget about this one.

Price aside, this is one of the best value investing books I've read. Of course a lot of the ideas have been put forward before--Klarman is a longtime resident of "Graham and Doddsville". But he does a great job explaining the philosophy and process in clear and simple language, and there are a few gold nuggets scattered throughout that might even be worth the $1000+ price tag. One simple rule he proposes: "If you don't quickly comprehend what a company is doing, then management probably doesn't either". Many investors in 2007 also could have benefited from Klarman's 1991 advice to "shun" financial institutions speculating in junk bonds or "complex mortgage securities". The book is full of these simple yet brilliant observations. Ignore the price, and spend an afternoon at the library with a copy. You'll be glad you did.

This book is pretty good. However the prices here are crazy.

True value investors would do a quick search and find the free pdf version available online.