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By downisland
April 10, 2008

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http://www.rbcpa.com/Notes%20To%20Margin%20of%20Safety.pdf

This is a wonderful read. It is by Ronald R. Redfield, CPA, PFS and is called Notes to the Book "Margin of Safety" by Seth Klarman. 1991. The "Notes" were published by Redfield May 3, 2006.


It is fun today to read older "how to succeed with investing" pieces and see which of the authors had super vision and which of the author's were blindly counting on the magic of leverage combined with a greater fool theory. Anyway, some gems from the notes:

Don't' confuse the company's performance in the stock market with the real performance of the underlying business. "Think for yourself and don't let the market direct you."

"Rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk."

"Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of the bargain is the key to the process."

"Investors can not predict when business values will rise or fall, valuation should always be performed conservatively, giving considerable weight to worst case liquidation value and other methods."

Investors fearing deflation could demand a greater discount than usual. "Probably let more pitches go by."


Value investors look for absolute performance not relative performance. They look more long term They are willing to hold cash reserves when no bargains are available. Value investors focus on risk as well as returns. He discusses that the greater the risk does not necessarily mean the greater the return. He feels that risk erodes returns because of losses. Price creates return not risk.

"The most important determinant of whether investors will incur opportunity cost is whether or not part of their portfolio are held in cash." "Maintaining moderate cash balances is likely to reduce the number of forgone opportunities."

He discusses how investing when interest rates are unusually low, could cause inflated share prices, and that one must be careful in making long term investments.

Klarman discussed how management can manipulate earnings so one had to be careful using earnings in valuation. And how book value provides limited information (like earnings) to investors. It should be considered as one component of thorough analysis.

"Value investing by its very nature is contrarian" He explains how value investors are initially wrong, since they go against the crowd and the crowd is pushing up the stock price. The Value incestor for a period of time and sometimes for along time will likely suffer paper losses.

"Investing is in some ways an endless process of managing liquidity" When a portfolio is in cash only, the risk of loss is non-existent. The same goes for the lack of gain when fully invested in cash. Klarman mentions "the tension between earnig a high return, on the one hand, and avoiding risk, on the other , can run high. This is a difficult task.
He suggests as few as fifteen different holdings would suffice for diversification. "Diversification is not how many things different you own, but how different the things you do own are in the risks they entail."

"Investors must learn to resist fear."
"Leverage is neither necessary nor appropriate for most investors."

After reading this again. I see why WEB was so cautious about equities and I see how maybe there is still some "gas" in today's stock prices. In light of future possible interest rates cuts, stagflation, our weakening economic forecasts, etc, many stocks may still have a ways more to go down.