A rare book that sheds light on value investing

That Leonardo’s Mona Lisa has calculable value is not in doubt. The proof would be that The Louvre is the world’s number-one museum, ranked by the number of visitors, and most of the 7.8mn who rolled up in 2022 paid a fee with the intention of craning their necks for a glimpse of the 30-by-21-inch beauty.

Thus a fairly simple present-value calculation can estimate a number for this exercise in mass idolatry. The chief inputs would be number of paying visitors, estimated proportion of revenue attributable to Lisa gazing, growth in visitor numbers and in entrance fees, number of years projected and the discount factor. Input those, press the ‘present value’ button and out pops the number. Easy.

Doing the same exercise for a book is trickier, though it depends on the book and the occasion. When the 500th anniversary of the publication of the Tyndale Bible comes due in 2026 we can be sure the homes of the three surviving copies of the first printing will monetise their good fortune, in the process providing the raw material for a valuation. That, however, will be the exception and even putting a figure on, say, a first edition of Pride and Prejudice is heavily influenced by the vagaries of the auction market (ball-park figure £80,000, according to Google).

Interesting, therefore, that last weekend’s edition of The Times should get especially excited that second-hand copies of a book written by a hugely successful investor should sell for upwards of $2,000 when its cover price on publication back in 1991 was $25. For assiduous readers of Investors’ Chronicle, this should be no surprise. Back in late 2012 when we profiled the author – Boston-based hedge-fund manager Seth Klarman – the book was already selling for £1,330 on Amazon. This week, according to AbeBooks, a trading platform for booksellers, the keenest price is £3,192.

Translating those figures into investment returns, Margin of Safety – that’s the title – has generated 8.7 per cent a year. That’s the annual compounding rate that takes £1,330 to £3,192 in 10.5 years and it easily beats the total return (capital gains plus dividends received) from the FTSE All-Share index. True, it falls short of returns from the equivalent for USA Inc, the S&P 500 (see table), but factor in the top price for Margin of Safety quoted by the four sellers who offer it on AbeBooks – £6,613 – and the return jumps to 16.5 per cent.

Clearly it is remarkable that the book should be so in demand since it is written by an investor known only to the most committed and whose profile is, say, a molehill on the slopes of Warren Buffett’s mountain. Remarkable, but also ironic because the title is borrowed from the final chapter of arguably the best-known investment text of all time, The Intelligent Investor by Benjamin Graham, who is caricatured as the founding father of investment analysis. In it, Graham said: “When confronted with a challenge to distil the secret of sound investment into three words, we would venture the motto, margin of safety.”

In layman’s terms, that means capturing an acceptable gap between value acquired and price paid; a gap sufficient to absorb the slings and arrows of outrageous investment fortune. But the irony lies in the point that to pay today’s going rate for a copy of the book is surely to abandon any pretence at capturing that margin between price and value. As a sensible investment, the book is a non-starter.

Conspicuous consumption

Okay, one line of argument could nullify that assessment. Klarman’s book might now be a ‘Veblen good’. This notion is named after an American economist, Thorstein Veblen, best known for coining the phrase ‘conspicuous consumption’. Relating to that, a Veblen good is a luxury item, the demand for which increases as its price rises. In other words, a Veblen good’s function is a signalling mechanism. It’s the human equivalent of the peacock’s fan and basically it says “Look at me – I’m so rich I can afford to waste money on tat like this”. With a print run of just 5,000 and who knows how many copies either lost or locked away, Margin of Safety qualifies nicely as a sort of Lamborghini Countach equivalent for wealthy investment nerds.

Another question is whether Margin of Safety does actually reveal closely-guarded investment secrets? Is it the investing equivalent of the Da Vinci code, a text hitherto accessible only to a chosen few? Will the effect of reading it transform a mundane investor into a superstar, generating the scale of returns that Klarman’s own investment firm, Baupost, has made since it was launched in 1982 after Klarman graduated from Harvard Business School with an MBA? If so, £3,000 or so would be a tiny price to pay because such returns are well worth having. Only insiders know the precise figures, but Baupost funds, which have been closed to new money for many years, have posted gains close to 20 per cent a year for 40 years; sufficient to turn Klarman into a billionaire and the fund’s partners into wealthy people.

While the returns are real enough, those questions are drivel. Margin of Safety offers no transformative knowledge. Nothing about it is even faintly esoteric. Indeed, its tenor is much along the lines of The Intelligent Investor and Buffett’s letters to shareholders of Berkshire Hathaway (BKK.B:US), the great man’s investment vehicle since 1965. ‘Homespun’ and ‘down to Earth’ are the sort of epithets that spring to mind.

Investor psychology

Much like Graham in The Intelligent Investor – the most recent edition of which (1973, actually) was updated by Buffett – Klarman is especially concerned with an investor’s mindset. “We shall say quite a lot about the psychology of investors. For, indeed, the investor’s chief problem – and even his worst enemy – is likely to be himself,” wrote Graham (or Buffett) in 1973. Similarly, writes Klarman in the introduction to his book, “this will be considered not a book about investing, but a book about thinking about investing”. His aim is firstly “by highlighting where so many go wrong, I hope to help investors learn to avoid those losing strategies”. Second, when investors are ready to follow the straight and narrow, he leads them to the path labelled ‘value investing’ since “the strategy of investing in securities trading at an appreciable discount from underlying value has a long history of delivering excellent investment results with very limited downside risk”.

Like Buffett, Klarman is also pretty good on the sound bites with which he peppers his text. Taking a couple of these at random, he notes that “many so-called value investors are what we would call ‘value pretenders’ – ‘buy-the-dips’ specialists, who buy what’s down but not necessarily what’s cheap”; or “it is far easier to identify the possible sources of growth for a business than to forecast how much growth will actually materialise”.

Perhaps unusually for a value investor, he notes that “when investors don’t demand compensation for bearing illiquidity, they almost always come to regret it”, adding that “because the opportunity cost of illiquidity is so high, no investment portfolio should be completely illiquid”.

He warns private investors that “given the vast amount of information for review and analysis, and the complexity of the investment task, a part-time or sporadic effort by an individual investor has little chance of achieving long-term success”.

That contention might well be debatable, especially as Klarman also makes the interesting point that “information generally follows the well-known 80/20 rule: the first 80 per cent of available information is gathered in the first 20 per cent of time spent. The value of in-depth fundamental analysis is subject to diminishing marginal returns”.

This seems to be another way of saying, don’t sweat the detail too much, or – as he adds – “investors frequently benefit from investment decisions with less-than-perfect knowledge and are well rewarded for bearing the risk of uncertainty”. Then again – and perhaps unusually for a value investor – Klarman emphasises the importance of timing in trades: “Trading – the process of buying and selling securities – can have a significant impact on one’s investment results.”

So is the most highly-priced investment text on the planet also the most valuable? Almost certainly not. It won’t give readers a grounding in finance theory or in understanding company accounts; not that it attempts to do so. For such matters, there is probably no beating what generations of finance students have labelled ‘Brealey & Myers’ or Principles of Corporate Finance in one of its more recent editions. As for understanding company accounts, there are many such texts, although it is debatable whether any do a better job than using the free material available for those who register with the International Accounting Standards Board.

Besides, the merit of Margin of Safety, perhaps more than anything, lies in its title. In that sense, it resembles another famous investment book that everyone says they have read, but, actually, almost no one has – Extraordinary Popular Delusions and the Madness of Crowds, a 19th century ramble through Tulipmania and the South Sea Bubble. Yet neither work needs to be read. To extract value, all that needs to be done is to focus on their titles. Thus an investor must seriously ask: “Am I getting a margin of safety if I buy this stock?” Or, when a market is going crazy, “Is this simply the madness of crowds?” Ask those questions critically and deeply at the appropriate moments and an investor will avoid many of the pitfalls that would otherwise ruin portfolio performance. That’s especially important because, as Klarman says: “Avoiding where others go wrong is an important step in achieving investment success. In fact, it almost ensures it.”

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bearbull@ft.com