Trade Like Seth Klarman

I first became intrigued by noted value investor Seth Klarman when I saw that his book, Margin of Safety, was "on sale" at Amazon for the low price of $700. The subtitle of the book is "risk averse value investing strategies for the thoughtful investor." Klarman started his hedge fund, The Baupost Group, in 1982, and currently manages $5.4 billion. One dollar placed in the fund is worth $55 today, a return of 5,500%, or over 20%+ a year.

According to his 2005 annual letter to investors, he believes "opportunity is scarce; when we sift through the debt, equity, and real estate markets around the world, we find few bargains." He believes the reason for this is "value investing itself has never been more popular. Fans of Warren Buffett now fill a sports stadium when they flock to Omaha in May for the Berkshire Hathaway annual meeting. Russell "value" stocks have outperformed Russell "growth" stocks for six consecutive years."

One thing you will likely note in reviewing his portfolio is the complexity and seemingly illogical positions Klarman holds. This is because he is a strong believer in finding an edge, and he doesn't believe that's because a stock is at a low P/E ratio or because it has a "good" balance sheet. His edge comes from dissecting seemingly complex situations to find value.

As I've done before in Trade like Jeff Berkowitz and Trade like Second Curve Capital, I will use his 13F-HR filing to study his style of investing. (The 13F-HR is a filing from institutions/funds with greater than $100 million in stock holdings, which are required by the Securities and Exchange Commission every quarter.

A common thread among Klarman's positions is to find companies that are experiencing some short-term pain, either because their industries are declining, competition is increasing, or commodity costs have caused margin pressures. Klarman is making the bet that either the pain will be cured, or that the stock has fallen so steeply (as in the case of USA Mobility below) that even if the pain sticks the stock is still cheap here for a potential buyer.

Now let's review some of his positions.

USA Mobility

USA Mobility (USMO - commentary - Cramer's Take) describes itself as "a leading provider of paging products and other wireless services to the business, government and healthcare sectors." Klarman isn't the only value investor in this one. Bruce Berkowitz of Fairholme is also long the stock. Berkowitz recently described his reasoning as follows: "USA Mobility was also a cheap buy of a company in another apparently dying industry -- radio paging.

However, like MCI, significant cash generation in relation to its market price at purchase created high potential returns with a margin of safety." He went on to say, "Fairholme is not prejudiced by whether a company is growing or shrinking, or whether it is large or small. We strive to understand businesses as if they were old-fashioned corner groceries, where each day the neighborhood purchased staples for cash, which was then used to re-supply and pay for the labor and capital needed to operate the store. Remaining cash in the till equaled the owner's earnings and together with its redeployment determined the store's value."

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At the time of publication, Altucher and/or his fund was long USMO, QLTI and JBSS, although positions may change at any time.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

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