1. Margin of Safety Seth Klarman

2. Macro EnvironmentMarket Inefficiencies Financial Distress / Bankruptcy Understand credit cycles Understand inflation Value of tangible & intangible assets Focus on why assets are undervalued and look for catalysts Index fund demand (supply) Demand by technical investors for high volume stock Accelerated growth = growth valuation Institutions: spinoffs, low price, suspend dividends, downgrades Share repurchase / issuance, spinoffs, recapitalizations, liquidations (internal), hostile takeovers / proxy fights (external) Chapter 6 Value Investing: The Importance of a Margin of Safety

3. FrameworkStrategy What is the business worth? How long will value sustain itself? What is likelihood the gap between price and value is realized? What is the potential risk / reward: when will value change or corrupt? Bottoms-up approach Absolute returns Risk Aversion Chapter 7 At the Root of a Value Investing Philosophy

4. Chapter 8 Business Valuation Content 3 Methods of Business Valuation Business Valuation Yardsticks

5. Chapter 8 Business Valuation Three Methods NPV AnalysisLiquidation ValueStock Market Value

6. Chapter 8 (cont.) Business Valuation Three Methods NPV Analysis Liquidation ValueStock Market Value Few businesses occupy impenetrable market niches, generate consistently high returns, and most are subject to intense competition Strength of sales in conjunction with pricing, sensitivity of demand to changes in price, competitors actions, and corporate tax rates all affect profitability Growth considerations include increased volume due to predictable increases in the general population, increased product use by customers, increased market shares, greater market penetration into the population, or price increase

7. Chapter 8 (cont.) Business Valuation Three Methods NPV Analysis Liquidation Value Stock Market Value Components Cash PP&E: depends on the ability to generate cash flow (consider: does it only have worth to the present owner?) Net Working Capital Current assets (cash, marketable securities, receivables, inventories) Current liabilities (accounts receivable, notes, taxes) Net Net Working Capital Net Working Capital – All long-term liabilities As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all its liabilities, and still distribute proceeds in excess of the market price to investors

8. Chapter 8 (cont.) Business Valuation Three Methods NPV AnalysisLiquidation Value Stock Market Value The stock market valuation of comparable businesses is but one of several valuation tools and provides a yardstick of what a securitiy, if not a business, might bring if sold tomorrow

9. Chapter 8 (cont.) Business Valuation Conventional Valuation Yardsticks Earnings Does not measure the cash generated or used by a business and is highly susceptible to manipulation Book Value – shareholders equity after liabilities are subtracted from assets Primarily affected by inflation, technological change and regulation Also affected by share issuance and repurchases Dividend Yield Too often struggling companies sport high dividend yields, not because the dividends have been increased, but because the share prices have fallen. Fearing that stock price will drop further if the dividend is cut, managements maintain the payout, weakening the company even more

10. Chapter 9 Investment Research Content Types of opportunities Investment Skepticism Market Inefficiencies and Institutional Constraints

11. Chapter 9 (cont.) Investment Research Opportunity Types Value Investing Risk Arbitrage / Complex Securities Financial Distress / Bankruptcy Securities selling at a discount to breakup or liquidation value Rate-of-return situations Asset-conversions % Low / % High lists Known exit prices Approximate time frames Distressed businesses Bankrupt businesses

12. Chapter 9 (cont.) Investment Research Skepticism If in 1990 you were looking for an ordinary, four-bedroom colonial home on a quarter acre in the Boston suburbs, you should have been prepared to pay at least $300,000. If you learned of one available for $150,000, your first reaction would not have been, “What a great bargain!” but, “What’s wrong with it?” Questions to ask Irrational / indifferent selling Contingent liabilities or pending litigation? Competition may be preparing to introduce a superior product

13. Chapter 9 (cont.) Investment Research Market Inefficiencies and Institutional Constraints Cannot buy low-priced spinoffs Sellers of securities involved in risk-arbitrage (on the grounds that their mission is to invest in ongoing businesses, not speculate on takeovers) Commonly unwilling to buy or hold low-priced securities

14. Chapter 9 (cont.) Investment Research Other Considerations Insider Buying and Management Stock Options Can Signal Opportunity

15. Chapter 10 Areas of Opportunity for Value Investors Content Catalysts Market Inefficiencies Institutional Constraints The attraction of some value investments is simple and straightforward: ongoing, profitable, and growing businesses with share prices considerably below conservatively appraised underlying value

16. Chapter 10 (cont.) Areas of Opportunity for Value Investors Catalysts Full value realization Sale / liquidation Partial Value Realization Spinoffs Share buybacks Recapitalizations Major Asset Sales