Invest Like a Pro

Margin of Safety, by Seth A. Klarman, is considered by many to be the Bible of value investing. The book can sell for as much as $2,500 on Amazon since it has been taken out of print. The introduction of this book alone is worth its weight in gold.

Klarman highlights the many reasons why and how investors tend to go wrong when investing and advises on how to avoid those losing strategies. He recommends a value investment philosophy involving the purchase of securities trading at an appreciable discount from underlying value. This he states, “has a long history of delivering excellent investment results with very limited downside risk.”

Klarman wisely warns against the temptation to speculate and trade, buying when prices are generally rising and essentially making high risk bets on optimistic predictions. Humans are comfortable going along with the crowd and doing what others have done; we would rather risk being wrong with everyone than be right on our own when deciding on investment opportunities. Investors are prone to be much more optimistic than reality often warrants. On the contrary, when prices are generally falling, fear of continued loss often causes investors to sell not fundamentals but rather on fear of those continued declines. Klarman illustrates this with an old story about sardine trading where he writes, “There is the old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, ‘You don’t understand. These are not eating sardines, they are trading sardines.’ Like sardine traders, many financial-market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification; why get rich slowly if you can get rich quickly? Moreover, speculation involves going along with the crowd, not against it. There is comfort in consensus; those in the majority gain confidence from their very number.”

Klarman politely calls technical analysis, a widespread form of speculation, a joke saying that, “Those who can predict the future should participate fully, indeed on margin using borrowed money, when the market is about to rise and get out of the market before it declines. Unfortunately, many more investors claim the ability to foresee the market’s direction than actually possess that ability. (I myself have not met a single one.) Those of us who know that we cannot accurately forecast security prices are well advised to consider value investing, a safe and successful strategy in all investment environments.”

Anyone with half a brain would see this quote as common sense as there have been no academic studies (or otherwise), that show with any level of statistical significance, that anyone in the entire world has ever been able to beat the market using technical analysis. The same negative cannot be said for fundamental analysis. Despite the obviousness of this statement there still are people who make their living talking about candlesticks, tea cups, head and shoulders and a bunch of other nonsense. These people lie to themselves and others, essentially ripping others off with complete nonsense much like a psychic feeds off of insecure fearful people looking for some meaning or positive assurance of good times to come in their lives. Klarman sums up this idea saying, “The correct choice for investors is obvious but requires a level of commitment most are unwilling to make… It is vitally important for investors to distinguish stock price fluctuations from underlying business reality…You must think for yourself and not allow the market to direct you.”

If investing were as easy as looking at moving day averages and “cup and handles” everyone would be rich. Nothing in life worth doing is easy and investing on technical analysis is pure speculation and gambling. Buying something that is well below its fair value is investing. Most people would agree that taking your paycheck and going to the local casino every payday is beyond foolish. Technical analysis is for lazy, incompetent, and uneducated investors that want to feel sophisticated using fancy terms like “head and shoulders” to rationalize to themselves and others that they are smart and great investors, but don’t want to put in the time and work that it takes to achieve true investing greatness. To this point Klarman writes, “It is never clear which future events are anticipated by investors and thus already reflected in today’s security prices. Because security prices can change for any number of reasons and because it is impossible to know what expectations are reflected in any given price level, investors must look beyond security prices to underlying business value, always comparing the two as part of the investment process.”

As an investor would one rather follow in the steps of legends like Soros, Klarman, Burry, and many more, or listen to the talking heads on CNBC discuss resistance channels and cup and handles? Can anyone name even one successful money manager that invests based on a head and shoulders pattern forming? Would you trust someone to trade your money on such nonsense? If you would, it’s likely you don’t have much money which could easily be explained by your apparent dismissive attitude toward hard work, research, and common sense. The Jeremy Grantham’s of the world don’t invest on charts and if you want to be rich, neither should you.