Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Out of print since the 1990s and never reprinted; used copies trade at collector prices.
Summary
Klarman published this in 1991 and never allowed it to be reprinted, which is why used copies sell for thousands of dollars. He runs the Baupost Group and writes from that practice. The book has three parts: where most investors go wrong, a philosophy of value investing, and the process of implementing it.
The first part is a critique of the institutional investment business. Klarman argues that most professional investors are constrained by relative performance measurement, career risk, benchmark tracking and the need to remain fully invested, all of which produce behaviour that conflicts with returns. He is particularly hard on the sell side, on the junk bond market of the 1980s, and on the willingness of institutions to buy securities they cannot value.
The second part states the position: investors should be absolute-return oriented, should treat risk as the probability of permanent loss rather than as volatility, should hold cash when opportunities are absent, and should demand a substantial discount to conservatively estimated value. Klarman argues that avoiding losses is the necessary condition, because the arithmetic of recovery from large drawdowns is punishing.
The third part covers where he finds opportunities, including bankruptcies and reorganisations, corporate liquidations, spinoffs, risk arbitrage, and complex or illiquid securities that institutions cannot hold. He gives valuation methods including net present value, liquidation analysis and stock market value of parts. The book is dated in its examples, which come from the 1980s, and its scarcity has given it a mystique disproportionate to its content. Much of the philosophy restates Graham. The value is Klarman's treatment of institutional constraints and of special situations, which few other writers cover with the same directness.
Key takeaways 8
- Risk is the probability and magnitude of permanent loss, not the volatility of quoted prices, and using volatility as the risk measure produces wrong decisions.
- Avoiding losses matters more than achieving gains, because recovering from a large drawdown requires a far larger percentage gain than the loss itself.
- Institutional investors behave in ways that harm returns because they are measured against benchmarks over short periods and face career risk for deviating.
- An investor should hold cash when no securities meet their criteria, rather than lowering standards to remain fully invested.
- Value investing requires estimating what a business is worth to a private owner and buying at a substantial discount to that figure.
- Opportunities concentrate in securities that institutions cannot or will not hold, including bankruptcies, spinoffs, liquidations and illiquid issues.
- Bottom-up analysis of individual securities is reliable while top-down forecasting of economies and markets is not.
- Investors who cannot state what a security is worth are speculating regardless of how much analysis they have performed.
Who should read it
Value investors who want a practitioner's account of institutional constraints and of special-situation investing, if they can obtain a copy.
About Seth Klarman
Founder and CEO, The Baupost Group, from 1982
A long public record at Baupost and one book, Margin of Safety, that became a value-investing touchstone despite never being reprinted.
Who recommended it 9 · 5 direct
“Seth Klarman's 'Margin of Safety' is a good book about risk.”
“Margin of Safety, published in 1991 – some concepts are timeless.”
“Some twenty years ago, Margin of Safety was published which spelled out why financial markets weren't, and never would be, efficiently priced and what we intended to do about it. I endeavoured to…”
Similar books 6
Chosen by shared topics, the entries that hold them, and the people who recommended both.
Treat stocks as parts of businesses and buy only with a margin of safety.
“I have been accused of telling all my secrets. I have written a number of books, and I reveal them all in these books.” — Benjamin Graham
Source: Graham on revealing everything he knows in his books
Recommended by: Benjamin Graham, Christopher Bloomstran and 27 others
How to read financial statements sceptically and value bonds and stocks.
“I've spent more time with all of the editions of Benjamin Graham and David Dodd's Security Analysis than with any other book” — Christopher Bloomstran
Source: Semper Augustus 2024 Letter to Clients, 'Books and Tunes for Walking', p. 95
Recommended by: Christopher Bloomstran, Howard Marks and 11 others
Traces the method from Graham through Icahn to the acquirer's multiple.
Recommended by: Mohnish Pabrai, Patrick O'Shaughnessy
The explicit argument for cloning rather than originating ideas.
“It is, without a doubt, my most recommended book on investing” — Andrew Wilkinson
Source: @awilkinson on X, 22 May 2024
Recommended by: Andrew Wilkinson, Guy Spier and 1 other
Berkshire's shareholder letters arranged by topic: governance, valuation, mergers.
“The resource is as valuable as Larry Cunningham's The Essays of Warren Buffett, which similarly organizes by subject matter” — Christopher Bloomstran
Source: Semper Augustus 2024 Letter to Clients, 'Books and Tunes for Walking', p. 96
Recommended by: Christopher Bloomstran, Francois Rochon and 11 others
Buy a few outstanding growth companies, research them by scuttlebutt, and hold.
“The late Philip Fisher wrote several books that are very good [including] Common Stocks and Uncommon Profits.” — Arnold Van Den Berg
Source: Van Den Berg on Fisher's books
Recommended by: Arnold Van Den Berg, Bill Stewart and 10 others
Where it sits in the reference 7
Topics