Seth Klarman – Value Investing Doesn’t Apply Only To U.S. Companies (2024)

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

Klarman is a value investing legend whorunsThe Baupost Group, one of the largest hedge funds in the U.S. He also wrote one of the best books ever written on investing calledMargin of Safety.Such is the popularity of Margin of Safetythat 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.

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 increaseour international efforts. This decision resulted in part from a realization that opportunities inthe U.S. were considerably less attractive than they had been, and that the situation would not necessarilyimprove. Our assessment was in part due to much higher valuations as well as to a perceptionof increased market efficiency over time, as more and larger investors have come into existence. It isstill possible to find opportunities in the U.S. equity market, but we believe it will continue to bemore difficult and less profitable than a few decades ago.

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

Some prominent U.S. investors have argued rather vociferously against international investing. Therisks and uncertainties are greater, they insist, the work far more demanding, and the track recordperhaps spottier. So I thought it might be interesting to reflect on the basic underlying principles ofvalue 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 securitiesbecause they alone offer a margin of safety. Over time, by again and again avoiding loss, you havetaken 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 freeoption on the recovery of that business and/or the restoration of that stock to investor favor. If anundervalued stock drops after you buy it and you are confident in your analysis, you simply buymore. All of these points apply equally well regardless of the market on which a stock trades orwhere a company does business.

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

One vocal objection I have heard to applying value investing principles overseas is that foreign companiesare not particularly shareholder-value oriented. Of course, Ben Graham invented value investingwhen the U.S. was effectively a foreign country to value investing principles. Certainly, in the1920’s and 1930’s, the idea of management running a company for the purpose of maximizingshareholder value was a totally “foreign” concept, one which didn’t really come into the mainstreamuntil the past decade and, even now, is certainly not an operative principle at all U.S. firms. Even afew decades ago, U.S. managements were hardly shareholder value oriented. No one was arguingthat you shouldn’t be a value investor then, when Warren Buffett, Max Heine, Tweedy Browne, and Ruane Cuniff were building their brilliant track records.

I frequently hear the argument that the rules are different overseas: the accounting murky, the annualreports unreadable, the currencies sometimes unhedgable. All of these points are fair, but, ratherthan being arguments to avoid foreign markets, they are instead arguments to embrace them. Afterall, 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 fundamentalanalysis rises proportionately with the difficulty of performing it.

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