Once you read a few investment books you soon realize that most money masters have simple rules. Warren Buffett has two: First, don't lose money. Second, never forget rule number one. (Actually he has one more: Wait for the perfect investment and do nothing until then.)
Ben Graham (Mr. Buffett's teacher) advised to buy stocks below working capital, or better still, below working capital less all debt -- which Mr. Buffett actually did for a while. Peter Lynch used to say, follow the earnings. If they rise, so will the stock. Other gurus have books with their rules and I own a bunch of such books -- as probably you do. But there is one investment book you can't buy -- Margin of Safety, written about 15 years ago by Seth Klarman, who runs about $5.5-billion (U.S.).
How good is Mr. Klarman? Well, he has produced a return of about 19 per cent per year over 23 years, which is not Warren Buffett (23 per cent annually over 30 years), but it is certainly impressive and worth reading about, if you could buy his book, that is, which you can't.
Well, actually you can, but it would set you back $1,150 on Amazon, which is what the lucky few owners demand to part with it. (Most library copies in existence have been stolen or gone missing.)
Why doesn't Mr. Klarman republish his book? Is it because he regrets having parted with the secrets? It's possible. But years ago I perused the book when it was still available, and also read about lectures that he gave at Wharton, his alma mater, so here for your delectation is the gist: Beyond the calculation of tangible value, and lots of sensible advice, Mr. Klarman's method first and foremost depends on guts. This is what you'll need to withstand the market panics and plunges, which is when Mr. Klarman recommends to buy.
The market, he says (quoting Ben Graham), is "fond of making mountains out of molehills, and making regular business setbacks appear as catastrophes." So eight times out of 10, panics are overdone. That's when you should buy, Mr. Klarman says. What if there are no panics to buy into? Then, Mr. Klarman says, hold cash, and wait patiently.
This simple double rule of guts and patience appears to be Mr. Klarman's secret to good performance. Why don't others follow it? Because, not surprisingly, it is easier said than done. First, there is much work involved: You must compute the bargain value of stocks meticulously, and if you find nothing absolutely cheap, you should stay in cash. How many could do that?
Second, you must have the guts to buy in the midst of crashes, disasters, shenanigans, cyclical downturns, or panics. How many could?
Third, because panics occasionally are justified, you must also have the honesty and humility to admit it when you are wrong, and get out.
Finally, beyond being a paragon of courage, brains, and honesty, a value investor à la Klarman must also have a thick skin, since buying into a plunge risks embarrassment in the near term if the plunge continues, while the hoped-for gain would happen (maybe) only in the future. Embarrassment now, versus potential gain later . . . the human animal is not built to choose correctly in such cases.
This is why I am sure that even if Mr. Klarman made his book available to all investors, there would be no guarantee they would act on it. Courage, honesty, stoicism -- one is more likely to learn them by reading classics or by fighting for a good cause than in an MBA or CFA program.
Certainly based on my 30 years of experience, I can tell you that buying into panics is hard. What does help is computing beforehand the absolute-bargain prices for good companies you'd like to own, and waiting for an earnings miss, revenue shortfall, war, stingy Fed, or just plain market dyspepsia to send the stock to your hoped-for level.
It helps if you also keep telling yourself that the risk has actually declined along with the stock price. Or, as Mr. Klarman puts it, the true risk is one of valuation -- paying more than the business's true value -- while the fictitious risk is one of quotation -- seeing the quoted price fall temporarily below the bargain price you had paid. The first is a true risk of loss. The second is a temporary risk of ego. Those who invest like Mr. Klarman will take the second risk any day, and avoid the first always.
Which is why value investors gravitate toward scandals and disasters, to seek potential bargains. Tyco provided such a good opportunity after its CEO was ousted. So did Hewlett Packard. Similar bargains appear daily. Which? Recently Imax dived in a selling panic despite good results because talks about a buyout came to naught. Is this a Klarman-type opportunity? I am not sure. But why not look into it?
There are others, to be sure. Peruse the newspaper and listen to the news. Which stocks have disappointed and plunged? Dig into them, then make up your mind whether the plunge is overdone, and what is the bottom price you'd be willing to pay for the business. If you can do that, you can make money when everyone else is losing their heads. Come to think of it, Rudyard Kipling said something like this in his poem If. In fact, if Mr. Klarman ever republishes his book, I would suggest he use that poem as an epigraph.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.