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By Rupert Hargreaves The following is a summary of Seth Klarman’s investing process as detailed in an interview with Barron’s on 4 November 1991 . Seth Klarman is always on the lookout for traditional value investments; he likes to buy a dollar for $.40, following in Benjamin Graham’s footsteps. This strategy is relatively straightforward, but it’s finding the ideas that’s the hard part. Click to enlarge Finding your own ideas is key Finding your own ideas when investing is integral to your own education. Anyone can follow the world’s most prominent investors into positions, but if you haven’t done the research yourself, it’s difficult to maintain conviction if the market moves against you. Moreover, if the position doesn’t work out, you can’t really learn from your mistakes if you didn’t have a set plan going in the trade. So, finding your own ideas and building an investment case around the information available to you is an extremely important part of the investment process. Klarman on searching for ideas How does Seth Klarman go about looking for ideas? Well, according to the Barron’s interview, around half of Klarman’s ideas have originated internally at Baupost. These ideas come from newspapers and magazines and there are several categories of ideas that Klarman looks for. The first is market inefficiency or imperfection to developments that are usually caused by institutional constraints. Many institutions have moved away from fundamental investing and this leads to opportunity. An example of this would be when a large company spins off a much smaller subsidiary and distributes the stock free to shareholders. The institutions tend to be natural sellers of the spinoffs. Seth says that whenever a spin-off is mentioned in the press or by one of his employees, it becomes an area of interest and something to research further. Another area where Baupost looks for ideas, or “rock to look under” as Klarman puts it, is when securities get downgraded from investment grade to below investment grade, i.e., distressed. Many investment funds aren’t allowed to hold non-investment-grade securities, so when the downgrade happens, they have to sell their position creating a short-term supply/demand imbalance. Once again, this is selling that’s not driven by fundamentals. Seth Klarman invests using a bottom-up approach, and while he does have a macro view, if the opportunities are there to be taken Baupost will invest, even if the economic environment is not perfect. And unlike many other firms, which rely on Wall Street forecasts to put together an economic outlook, Baupost builds its view of the economy by talking to other investors and company management teams – a simple approach but one that gives a more realistic view of the economy and its underlying trends. I am going to end this article with a short quote from the Barron’s interview as I think, even though it is around 25 years old, the quote is still highly relevant for today’s market: “I think the market is just as vulnerable to a sudden correction, and a very sharp sudden correction. For one thing, as I said, I think we have a market of fully invested bears. The institutional investors, being short-term and relative-performance oriented, are trying to all beat each other every three months, and hence will react to which ever direction the market is going in. As long as the market is generally flat to rising, they will stay in the market. But if they perceive that the market is going down — in other words, if the market starts to go down — they may all decide to get out at once, none of them wanting to be in longer than anybody else. We have put on a few circuit breakers, but they don’t address the fundamental problem of professional investors who feel compelled to stay in and hold overvalued securities.” – Source: Seth Klarman: 4 November 1991 Barron’s interview Disclosure: Rupert may hold positions in one or more of the companies mentioned in this article. You can find a full list of Rupert’s positions on his blog. This should not be interpreted as investment advice, or a recommendation to buy or sell securities. You should make your own decisions and seek independent professional advice before doing so. Past performance is not a guide to future performance.

The reason it is so important to not be emotional when investing and only rely on the numbers is because many of your fellow investors on Wall Street simply do not have a clue of what they are doing, and are basically gambling instead of investing. They latch on to what they think is a good idea, but then invest without kicking the tires or looking what’s under the hood. The reason I created Friedrich was to even the playing field for the average investor, so they should never have to experience what investors in this stock experienced on Friday: Click to enlarge Click to enlarge Momentum investing can be very profitable if you get in at the right time, but in the end, can be extremely dangerous, as you are hoping that the company will continue giving Wall Street what they want to hear. Unfortunately for those investors in LinkedIn (NYSE: LNKD ), they found out that the LinkedIn Emperor really had no clothes and was actually standing there naked – and before they could sell, had their shares decimated, as high frequency trading computers evaporated billions of dollars from the stock in milliseconds. It is important for every investor to do their due diligence on Main Street before anything else and only go to Wall Street and buy after their Main Street analysis has been completed and they have determined that they are getting a bargain. Luckily, our Friedrich Algorithm goes a long way in doing that for us, and in about 13 seconds, allows anyone using it to (in the great majority of cases) avoid such disasters. I have updated the introduction to Friedrich and you can find it here , so you can see the descriptions of the 34 proprietary ratios that I have created over the last 31 years in designing Friedrich to get him to this point. The Friedrich Algorithm can do in 13 seconds what used to take me one month to do by hand. Thus, I can upload 50 new data files a day and eventually have 1000s of stocks analyzed over time. As momentum plays get hammered, those on the margin get wiped out and then are forced to sell their other holdings, just to meet their margin calls. And with margin at all-time highs, it is even more dangerous now than at any time before. Click to enlarge As you can see, the S&P 500 Index closely follows the pattern of margin debt, so if investors start getting their clocks cleaned, then before you know it, the market continues its slippery slope downward, and those who bought without doing any research and who also bought on margin will find out real fast how dangerous it is to invest in the markets if you don’t know what you are doing. Why do I say we are in a bear market? Well, the level of losses since January 1st have been so fast and furious, and with Friedrich not being able to find anything to buy, I can only imagine as panic sets in and the margin calls come fast and furious that sellers will outweigh buyers going forward. Click to enlarge This, in the end, is no time to be a hero!