Saturday, April 18, 2009

Margin Of Safety: Chapter 2

What's good for Wall Street is not necessarily good for investors, according to Klarman. Because of how Wall Street does business, it has a very short-term focus. For example, Wall Street makes money up-front on commissions (not from long-term performance), therefore the Street will always push for churn and will always push "hot" investments.

Klarman argues that there is nothing fundamentally wrong with this business model. After all, many professionals (consultants, lawyers, doctors) make money in this manner without being responsible for the long-term results. But what's important is that investors recognize this Wall Street bias, or they will be robbed blind.

This business model also encourages very short-term thinking, and a bullish bias. If stocks are going up, Wall Street is able to make more in the form of commissions. Klarman sees evidence of this bullish bias in the percentage of stocks that are recommended by analysts versus those that are deemed "sells".

Klarman provides many examples of Wall Street's short-term bullishness that props up prices of various securities, but where those prices eventually fall dramatically. He advises investors to keep Wall Street's biases in mind when dealing with the Street, and to avoid depending on the Street for advice.

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