Friday, 2 October 2015

A few quotes from Seth Klarman's "Margin of Safety"

I'm currently about 2/3rds through Klarman's book, and to state that it's likely one of the best books on investing I've ever read would be an understatement.

On the subject of Valuation, Klarman advocates three approaches, 1) NPV / DCF, 2) Private Market Comparable Value, and 3) Comparable Stock Market Value

I'll do a more detailed post on all three at some point.  For now, I want to point out that nowhere in Klarman's arsenal is DDM used in any shape, way or form.  He had the following to say about the short-comings of using DDM:

"The only cash flows that investors typically receive from a stock are dividends. The dividend-discount method of valuation, which calculates the present value of a projected stream of future dividend payments, is not a useful tool for valuing equities; for most stocks, dividends constitute only a small fraction of total corporate cash flow and must be projected at least several decades into the future to give a meaningful approximation of business value. Accurately predicting that far ahead is an impossibility."

And, on the topic of dividend yield:

Dividend Yield

Why is my discussion of dividend yield so short? Although at one time a measure of a business's prosperity, it has become a relic: stocks should simply not be bought on the basis of their dividend yield. Too often struggling companies sport high dividend yields, not because the dividends have been increased, but because the share prices have fallen. Fearing that the stock price will drop further if the dividend is cut, managements maintain the payout, weakening the company even more. Investors buying such stocks for their ostensibly high yields may not be receiving good value. On the contrary, they may be the victims of a pathetic manipulation. The high dividend paid by such companies is not a return on invested capital but rather a return of capital that represents the liquidation of the underlying business. This manipulation was widely used by money-center banks through most of the 1980s and had the (desired) effect of propping up their share prices. 

Finally, on the topic of Value Investing:

Beware of Value Pretenders

"Value investing" is one of the most overused and inconsistently applied terms in the investment business. A broad range of strategies make use of value investing as a pseudonym. Many have little or nothing to do with the philosophy of investing originally espoused by Graham. The misuse of the value label accelerated in the mid-1980s in the wake of increasing publicity given to the long-term successes of true value investors such as Buffett at Berkshire Hathaway, Inc., Michael Price and the late Max L. Heine at Mutual Series Fund, Inc., and William Ruane and Richard Cunniff at the Sequoia Fund, Inc., among others. Their results attracted a great many "value pretenders," investment chameleons who frequently change strategies in order to attract funds to manage.

These value pretenders are not true value investors, disciplined craftspeople who understand and accept the wisdom of the value approach. Rather they are charlatans who violate the conservative dictates of value investing, using inflated business valuations, overpaying for securities, and failing to achieve a margin of safety for their clients.  

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