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Seth Klarman on Looking for Bargains

- By Rupert Hargreaves

Seth Klarman (Trades, Portfolio) is one of the world's most respected value investors, and he is an investor I have done a substantial amount of work on in the past. Klarman's style of investing is simple; he is on the lookout for companies trading at a deep discount to intrinsic value. This is not as simple as it seems however. Klarman's particular style of value investing is not just limited to estimating how a particular company will grow over the next few years. Instead, Klarman is on the lookout for businesses trading at a deep discount to their current asset value. More often than not, trying to find these companies requires plenty of work, which puts investors off.

Looking through Klarman's portfolio, it is clear even the rest of the world's most renowned value investors are afraid to follow his lead on several positions. Take Viasat Inc. (VSAT) for example. Of the many great value investor portfolios tracked by GuruFoucs, Klarman is one of four investors to hold a stake in the satellite provider. PBF Energy Inc. (PBF) is another position Klarman likes but the rest of Wall Street appears to hate.

To help shed some light on why Klarman likes these positions, as well as offering some insight into his investment process, I have gathered some quotes from the great investor as published in his various books, interviews and investor correspondence throughout the years.

On looking for bargains

"Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse."

"Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis."

"You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy."

"The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of 'private market value' as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism."

"Beware leverage in all its forms. Borrowers - individual, corporate or government - should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn."

"Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty - such as in the fall of 2008 - drives securities prices to especially low levels, they often become less risky investments."

"Attention to risk must be a 24/7/365 obsession, with people - not computers - assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science."

Disclosure: The author owns shares in PBF Energy, but no other stock mentioned.

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This article first appeared on GuruFocus.