Margin of Safety by Seth Klarman Summary

Would you spend $350 on a book to learn about investing? Well, that is the current price to purchase the book "Margin of Safety" by Seth Clarman. This book is so rare that it is arguably one of the hardest investing books to get a hold of. Thankfully, I was able to find a copy of the book and read it, so you don't have to.

For those of you that don't know, Seth Clarman is one of the most highly respected value investors of all time. Since joining the hedge fund Beau Post Group in 1983, Clarman has not only produced unrivaled returns in excess of 20% per year, but he's also, from time to time, offered wise and timeless commentary on markets and the craft of investing. Here are the eight most important takeaways from his book that will make you a better investor. All of these takeaways are especially useful in today's market. Number five is my personal favorite. Let's jump right in.

Given that the name of this book is literally called "Margin of Safety," it's only fitting to start this book summary and main takeaways by explaining this concept. The concept of margin of safety is fundamental to what is referred to as value investing, and if you have watched my videos, you know I talk about it frequently because it is crucial to successful investing. Margin of safety comes from a concept in engineering.

Let me explain what I mean. Imagine you are the head engineer designing and constructing a bridge that crosses over a dangerous body of water. You want this bridge to be able to support 10,000 pounds on it without falling. However, you wouldn't want to make the bridge only be able to support 10,000 pounds; you would want to make it stronger than that and have it be able to support more than just 10,000 pounds. For safety purposes, you would want it to be able to support, let's say, 15,000 pounds.

Even though you would put a sign on the bridge warning that it can only support 10,000 pounds, you would design it to support more weight to factor in anything that could go wrong, such as errors in your design or people not using the bridge correctly. The difference between the 10,000 pounds you say the bridge can hold and the 15,000 pounds it can actually hold is 5,000 pounds. This is what is referred to as your margin of safety.

This same concept applies to investing. You wouldn't want to buy a stock for $100 a share if you determine its true value or intrinsic value is also $100. You would only want to buy that stock that is selling for $100 a share if its intrinsic value is higher by a significant amount, let's say $150. The $50 difference between what the stock is truly worth and what you paid for it is your margin of safety. It protects you from losing money in case your estimate of the intrinsic value is wrong, or if the underlying business's performance deteriorates after you purchase it over a short period of time.

Don't confuse the real success of an investment with its mere success in the stock market. The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value. Likewise, a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration.

It is vitally important for investors to distinguish stock price movements from the underlying business reality of that particular stock. It is human nature to want to buy stocks that you see going up in price and to sell stocks that have recently declined in price. However, investors must actively control these emotions in order to become a successful investor. Don't completely ignore movements in the stock market, but instead see where you can use these movements to your advantage.

That can be buying more of a stock you already own because the price declined while the true value of the stock remains unchanged, or even selling a stock if the price has increased dramatically compared to what you think the stock is worth. Unsuccessful investors are dominated by emotion; rather, they're responding coolly and rationally to market fluctuations. They respond emotionally with greed and fear.

We all know people who act responsibly and deliberately most of the time, but act completely different when investing money. It may take them many months, even years of hard work and discipline saving to accumulate the money, but only a few minutes to invest it. Look no further than the recent meme stock craze in Wall Street Bets as an example of this in action.

Today, people spend hours reading reviews online before purchasing the latest piece of technology, but go out and buy stock without doing any research just because they heard about it on an online forum. Rationality that is applied to the purchase of electronics is absent when it comes to investing. For many people, it's not just the individual investor that makes mistakes when investing; professional investors do things that don't make logical sense too.

These investors, referred to as institutional investors, frequently do things that are against the long-term best interests of investors in the funds they manage. Professional investment managers frequently move hundreds of billions of other people's hard-earned dollars into investments based on little or no in-depth research or analysis. The prevalent mentality on Wall Street is consensus and groupthink; acting with the crowd ensures an acceptable return, even while acting independently runs the risk of unacceptable underperformance.

There's an old saying on Wall Street that no investment manager ever got fired for buying IBM stock. This means that you don't have to worry about losing your job as a professional investor if you are wrong, as long as everyone else is also wrong. Additionally, most large money managers are paid not according to the results they achieve, but as a percentage of the total assets they manage. The incentive is to expand managed assets in order to generate more fees.

Yet while a money management business typically becomes more profitable as assets under management increase, good investment performance becomes increasingly difficult. This conflict between the best interest of the money manager and that of the clients is typically resolved in the manager's favor.

Before we move on to the next takeaway, and my personal favorite, I just want to take a quick moment and thank you for watching the video. If you aren't already, make sure to subscribe and hit the bell icon so you don't miss out on any of the knowledge that can help make you more money in your investment portfolio. Our community of investors is approaching 60,000 strong, and it would be even better with you as a part of it.

Now, let's get back into the video. Most institutional investors have become locked into a short-term investing mindset where they care too much about their fund's short-term performance relative to that of their competitors. Many fund managers get their performance updated as much as every hour of the day, so they always know how their portfolio is doing. Fund managers are provided daily comparisons of their results with those of managers at other firms.

Frequent comparative ranking can only reinforce a short-term investment perspective. There is so much pressure on professional fund managers to perform in the short term that they become laser-focused on the short-term movement in stock prices and tend to ignore the long-term potential of a stock. This is where you, as an individual investor, can have a huge advantage over a professional fund manager.

All you need to do is focus on the long term. When you buy a stock, you should not be overly concerned with what that company and stock are going to do over the next few months or even the next year. Instead, you should be thinking about the long-term growth potential of that stock. Not having to worry about short-term movements in stock prices is a huge advantage; make sure you use it.

Warren Buffett likes to say that the first rule of investing is, "Don't lose money," and the second rule is, "Never forget the first rule." The primary goal of every investor should be to avoid loss. This does not mean that investors should never incur the risk of any loss at all; rather, "Don't lose money" means that over several years, an investment portfolio should not be exposed to permanent loss of principle.

While no one wishes to incur losses, you couldn't tell from looking at the behavior of most investors and speculators. The urge to gamble in the market is in almost every human. The possibility of getting rich quickly can be compelling, especially when others appear to have had success with risky short-term investments.

Avoiding losses is such a powerful way to build wealth. Think about this example: Let's say you have $1,000 and lose 50% of it on a speculative investment. You now have $500. What return would you need to break even and get back to your $1,000 starting point? Maybe at first thought, you think you need a 50% positive return since that's the opposite of the 50% loss you suffered. But that's not the case.

In order to get back to your initial starting point of $1,000, you need a 100% return on the $500. This example perfectly illustrates why successful investors are focused more on not losing money than necessarily what they can gain from an investment. Over an investing career, avoiding loss can work wonders for an investor's portfolio.

Building on the previous point, in addition to the probability of permanent loss attached to an investment, there is also the possibility of short-term price movements that are unrelated to the underlying value of a stock. Many professional investors and academics judge the riskiness of a stock based on its volatility. Put simply, stock market volatility is a measure of how much a stock price moves up and down.

Many investors consider these short-term price movements to be a significant risk. If the price goes down, the investment is seen as risky, regardless of the fundamentals. But are temporary price movements really a risk? While investors should obviously try to avoid overpaying for investments or buying into businesses that decline in value due to deteriorating results, it is not possible to avoid random short-term market volatility.

Investors should actually expect prices to fluctuate and should not invest in stocks if they cannot tolerate some volatility. The short-term movement of stock prices can actually be a great thing for the long-term investor. These price movements can be taken advantage of by long-term focused value investors. You can buy more of a stock when the price of a stock falls without the fundamentals of the business declining, or you can take advantage of rapid stock price increases by selling your shares to investors who are more optimistic about the future of the business than you believe is justified.

The great part about investing is that you can be extremely patient. You don't have to make a certain number of investments over a period of time. You can go weeks, months, or even years without making an investment. True value investors are not influenced by the way others are performing; they are motivated only by their own results. They have infinite patience and are willing to wait until they see an undervalued investment opportunity.

Value investors will not invest in businesses that they cannot readily understand or ones they find excessively risky. Most institutional investors, unlike value investors, feel compelled to be fully invested at all times because there is this pressure. Institutional investors frequently invest in things that they don't fully understand or aren't as attractive as other opportunities that may have come along had they had been more patient.

When attractive opportunities are plentiful, value investors are able to sift carefully through all the bargains for the ones they find most attractive. When attractive opportunities are scarce, however, investors must exhibit great self-discipline in order to maintain the integrity of the valuation process and limit the price paid. Above all, investors must always avoid investing in something that they don't understand.

If you like this video, make sure to check out the summary of another all-time great investing book, "The Intelligent Investor." Here, also leave a comment and let me know what other books you want to see me put together a summary for. Talk to you soon.