Value Investing

In these super-hyped hysterical times, where people say contradictory things all over the place, it is useful to get some wisdom from the smart money. I read some recent notes from a speech recently given by Seth Klarman, who is recognized as one of the great value investors of our time. I'd like to share some with my small audience.

“Many investors lack a strategy that equips them to deal with a rise in volatility and declining markets. Momentum investors become lost when the momentum wanes. Growth investors - who pay a premium for the fastest growing companies - don't know what to do when the expected growth fails to materialize. Highly leveraged investors, like some quant funds in the headlines, were recently forced to sell regardless of value when their methodology produced losses rather than gains. Counting on a government bailout for every market crisis seems a dicey proposition, especially when supposedly impossible events happen on Wall Street every few years."

Makes you think a little bit. Then he sounds a bit like Graham talking about "margin of safety".

"Value investing, the strategy of buying stocks at an appreciable discount from the value of the underlying businesses, is one strategy that provides a road map to successfully navigate not only through good times but also through turmoil. Buying at a discount creates a margin of safety for the investor—room for imprecision, error, bad luck or the vicissitudes of volatile markets and economies. Following a value approach won’t be easy for everyone, especially in today’s media-dominated, short-term oriented markets, in that it requires deep reservoirs of patience and discipline."

Preaching to the choir I suspect. Did everyone get the part about patience and discipline, "deep reservoirs". The next section seems extremely timely.

"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 in bad."

Panic... does anyone know of a panic lately? Then he talks about why value investing works.

“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 predicated on the proposition that the efficient-market hypothesis is frequently wrong."

Pretty much like JG's book where he asks why the value of GM can vary so much in a single year, "the market sometimes just goes nuts. Now I think his next comments are critical. He discusses situations and why the market is inefficient.

“Institutional constraints and market inefficiencies are the primary reasons that bargains develop. Investors prefer businesses and securities that are simple over those that are complex. They fancy growth. They enjoy an exciting story. They avoid situations that involve the stigma of financial distress or the taint of litigation. They hate uncertain timing. They prefer liquidity to illiquidity. They prefer the illusion of perfect information that comes with large, successful companies to the limited information from companies embroiled in scandal, fraud, unexpected losses or management turmoil."

Did everyone get the part about scandal, fraud, management turmoil? This has been a debate on the Groups board. Many people there say they won't buy companies that are under investigation etc. I think they're missing a potential major opportunity in doing that. He then gives some buying opportunity examples, a bit like JG's first book.

1. Seek situations where there is urgent, panicked or mindless selling.
2. Institutional selling of a low-priced small-capitalization spinoff.
3. If a company fails to declare an expected dividend, institutions restricted to owning dividend-paying stocks may unload shares.
4. Market inefficiencies, like tax selling and window dressing.
5. The deletion of a stock from an index.

Not sure if all these will be subject to MFI stocks, but worth keeping in back of mind. He did have another relevant comment that I can't find right now. But the essence is that successful value investing involves work and research. Not sure if a "Magic Formula" quite fits that criteria.

I went to Gurufocus.com to see what Mr Klarman is buying.
NWS
ELOS (used to be on the list)
UFS (who are they?)
MAQ (ditto)
EXH
BR (this used to be Burlington Resources I think, but they were bought by COP)
HRZ
NFG (I owned these guys a couple years ago)

Many more besides that, he doesn't exactly subscribe to Pabrai's limited holdings. Getting late time to call it a night. Hope this made everyone think a little about the journey we're on.