A Margin of Safety Primer

I almost always recommend a reading of the quarterly shareholder letter from Martin Whitman of Third Avenue funds. The first quarter of 2012 is no exception. In fact, it’s a special letter because Whitman recently stepped down as manager of the Third Avenue Value fund. The latest letter is a primer on Whitman’s version of value investing with a margin of safety. The Third Avenue method is dramatically different from contemporary security analysis. Whitman focuses on the balance sheet. He wants to buy assets for less than they are worth. Most analysts look at the income statement. Whitman believes this is mistaken for several reasons. Earnings and income can be manipulated. Quarter to quarter earnings can be volatile and hard to anticipate. Plus, a business ultimately is worth what it’s assets are worth, not a multiple of its earnings.

Whitman goes on to offer more details of how he and his team analyst businesses and securities. It’s not often you have access to such insights free. Take advantage of it.

A good example of how we meld the top-down with the
bottom-up lies in the reasoning behind our investments in
Hong Kong, China and South Korea. The top-down
analysis centers on the belief that over the next three to
seven years, that part of the world will grow faster than the
rest of the industrialized world, especially Europe and North
America. The bottom-up analyses center on the facts that
the businesses in which Third
Avenue has invested are all eminently
credit worthy; that the common
stocks were acquired at significant
discounts to our estimate of NAV;
and that the common stocks are the
issues of companies that provide
comprehensive, written, disclosures;
and are regulated by government
agencies whose principal interest
seems to be investor protection.