Seth Klarman – Value Investing Doesn’t Apply Only To U.S. Companies

Seth Klarman – Value Investing Doesn’t Apply Only To U.S. Companies
By Hedge Funds [CC BY 3.0], via Wikimedia Commons

One of our favorite investors here at The Acquirer’s Multiple – Stock Screener is Seth Klarman.

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Klarman is a value investing legend who runs The Baupost Group, one of the largest hedge funds in the U.S. He also wrote one of the best books ever written on investing called Margin of Safety. Such is the popularity of Margin of Safety that at the time of writing there are 15 used copies selling for $940 and 6 new copies selling for $1500.

I was recently re-reading Klarman’s 1997 Baupost Shareholder Letter in which he discusses why value investing doesn’t apply only to U.S. companies.

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Here’s an excerpt from that letter:

Increased International Focus

The most important investment decision we have made over the past several years is the one to increase our international efforts. This decision resulted in part from a realization that opportunities in the U.S. were considerably less attractive than they had been, and that the situation would not necessarily improve. Our assessment was in part due to much higher valuations as well as to a perception of increased market efficiency over time, as more and larger investors have come into existence. It is still possible to find opportunities in the U.S. equity market, but we believe it will continue to be more difficult and less profitable than a few decades ago.

Another key component of our decision to look overseas was the identification of compelling bargains in numerous European markets, one at a time, bottom up. We believe that we are at the beginning of a period of value realization in a number of these markets, and Baupost now has the capability to identify and rigorously analyze and monitor opportunities in foreign countries.

Some prominent U.S. investors have argued rather vociferously against international investing. The risks and uncertainties are greater, they insist, the work far more demanding, and the track record perhaps spottier. So I thought it might be interesting to reflect on the basic underlying principles of value investing and evaluate possible reasons why they wouldn’t work overseas.

The main underlying principle of value investing is that you should invest in undervalued securities because they alone offer a margin of safety. Over time, by again and again avoiding loss, you have taken the first step toward achieving healthy gains. Value investors should buy assets at a discount, not because a business trading below its obvious liquidation value will actually be liquidated, but because if you have limited downside risk from your purchase price, you have what is effectively a free option on the recovery of that business and/or the restoration of that stock to investor favor. If an undervalued stock drops after you buy it and you are confident in your analysis, you simply buy more. All of these points apply equally well regardless of the market on which a stock trades or where a company does business.

Value investing in the U.S. is driven by fundamental analysis, a rigorous assessment of underlying value based on an understanding of a particular business or asset. The same principles that apply here, such as not paying up for growth, or buying businesses you can understand that are not subject to rapid technological change or obsolescence, apply internationally as well.

One vocal objection I have heard to applying value investing principles overseas is that foreign companies are not particularly shareholder-value oriented. Of course, Ben Graham invented value investing when the U.S. was effectively a foreign country to value investing principles. Certainly, in the 1920’s and 1930’s, the idea of management running a company for the purpose of maximizing shareholder value was a totally “foreign” concept, one which didn’t really come into the mainstream until the past decade and, even now, is certainly not an operative principle at all U.S. firms. Even a few decades ago, U.S. managements were hardly shareholder value oriented. No one was arguing that you shouldn’t be a value investor then, when Warren Buffett, Max Heine, Tweedy Browne, and Ruane Cuniff were building their brilliant track records.


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I frequently hear the argument that the rules are different overseas: the accounting murky, the annual reports unreadable, the currencies sometimes unhedgable. All of these points are fair, but, rather than being arguments to avoid foreign markets, they are instead arguments to embrace them. After all, as an investor you never have perfect information, and the biggest profits are always available (just as they have been in the U.S.) when competition and information are scarce. The payoff to fundamental analysis rises proportionately with the difficulty of performing it.

Through this general line of thinking, you might conclude that future returns will be lowest in expensive markets and greatest in cheap ones; lowest where information is plentiful and straightforward, and greatest where it is scarce and hard to interpret; and lowest when markets are priced to reflect shareholder-oriented management and greatest where managements are currently indifferent. All of this, I believe, is the case, and the next decade should prove it.

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”
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