Walter Schloss was a flexible investor. He’s the perfect example of someone who stayed true to his investment philosophy but adjusted his strategy to the changing times.
The changes Schloss made weren’t drastic like Warren Buffett though. Schloss knew his limits. His strategy changed slightly over decades because he had no choice. The opportunities disappeared.
In the late 1940s at Graham-Newman, under Ben Graham’s tutelage, he hunted for Graham’s net-nets — companies trading below net working capital or net current assets.
That strategy carried over to his own firm in the 1950s until the opportunities dried up. With net-net’s no longer prevalent, he relied more on book value. First, he looked for stocks trading at a third of book value, then book value or less, and finally, a slight premium to book value. Other factors were involved but he understood assets best.
Schloss’s gradual evolution over his 45-year investing career paid off. His limited partners benefited with a 15.7% annual return after fees.
A fee structure, by the way, that would make any fund managers squeamish. Schloss believed his pay should be tied to success. So he got 25% of realized gains. But if there were losses, his limited partners were made whole before he earned a cent. He only got paid when his partners made money.
Investors can learn a lot from Schloss’s six-decade-long career. Thankfully, he shared his experiences over the years.
On Deep Value Investing
We live in a society that changes, so you can’t be too strict about the rules you had 40 or 50 years ago. You can’t buy stocks on the basis you did then. We would buy companies selling for less than their working capital, but now you can’t do it. Those companies would get taken over.
I really have nothing against earnings except that in the first place earnings have a way of changing. Second, your earnings projections may be right, but people’s idea of the multiple has changed. So I find it more comfortable and satisfying to look at book value.
Basically, we like protection on the downside… By using book value as a parameter we can protect ourselves on the downside and not get hurt too badly.
At such a time these companies and industries get into disrepute and nobody wants them, partly because they need a lot of capital investment and partly because they don’t make much money. Since the market is aimed for earnings, who wants a company that doesn’t earn much?
So if you buy companies that are depressed because people don’t like them for various reasons, and things turn a little in your favor, you get a good deal of leverage.
The thing about buying depressed stocks is that you really have three strings to your bow: 1) earnings will improve and the stocks will go up; 2) someone will come in and buy control of the company; or 3) the company will start buying its own stock and ask for tenders.
The thing about my companies is that they are all depressed, they all have problems and there’s no guarantee that any one will be a winner.
We want to get long-term capital gains and when you buy a depressed company it’s not going to go up right after you buy it, believe me. It’ll go down. And therefore you have to wait a while for that thing to go around and it seems about, four years seems to be about the amount of time it takes. Some take longer.
On Portfolio Construction
One of the things we’ve done – Edwin and I – is hold over a hundred companies in our portfolio. Now Warren has said to me that, that is a defense against stupidity. And my argument was, and I made it to Warren, we can’t project the earnings of these companies, they’re secondary companies, but somewhere along the line some of them will work. Now I can’t tell you which ones, so I buy a hundred of them. Of course, it doesn’t mean you own the same amount of each stock. If we like a stock we put more money in it; positions we are less sure about we put less in.
The important part is to have some money in the stock. If you don’t have any money in a stock you tend to forget about it. We then buy the stock on the way down and try to sell it on the way up.
I think it’s much easier to identify when something is cheap rather than when to sell. We would probably sell at where the stock sold out in the past when earnings had recovered. If we think there is a possibility of a deal we are tougher on our sell price. Sometimes we sell when the whole industry has moved up sharply, and there are also times when we sell because we find something better or cheaper. In value investing, if you find A has gone up but B is much cheaper you switch to the cheaper but generally we sell after a period of one year to get the benefit of taxes.
We often find that we sell a little too early. But when you sell something you have to make it attractive for someone to buy it. So if you wait to the point where the stock is really overvalued then you run the risk of nobody wanting to buy it and it could go down again.
I will say this, since we sell on a scale, most of the stocks we sell go up above what we sold them at. You know, you never get the high or you never get the low.
Sell is tough. It’s the worst. It’s the most difficult thing of all and you have an idea of what you want to sell it at and then you sometimes are influenced by the changes that take place.
I think people trade too much, looking for short-term gains. But I don’t think you should hold stocks indefinitely.
It’s also important to know what you know and what you don’t know. Templeton, for example, does something that I think is brilliant that I’m incapable of doing — he buys securities all over the world. I’ve found the few times that I’ve bought outside the United States, I’ve had my head handed to me — not every time, but most often.
One of the things you learn in this business is humility because you see your mistakes the next day. Many people make a mistake but they don’t see it in the paper the next day.
Most people who have been really successful in the securities markets say the same thing — that they’re not smart enough to get into the market and out of it. So they tend to remain more or less in the market at all times.
If you own a stock which is a takeover attempt, do you sell it once you’ve gotten a big profit or is it better to stay with it until the deal goes through? It’s a tough one. We’ve made mistakes. It’s very difficult to know which way to go.
Sometimes, we may also be a little too greedy. For example, we may sometimes get into securities where there’s too much leverage. When leverage goes against you, it can be very dangerous. We try to stay away from those kind of situations.
The problem in investing, I think, is timing. You may be right. But in the long run, we’re all dead. Even if you’re right, if it takes 20 years to work out, it can be a disaster.
Certainly, the people in 1929 who bought stocks because of the future growth potential of a particular industry were correct in that they saw a long-term growth to our economy. Unfortunately, these investors had to wait, in many cases, 25 years before the stock market gave them a decent profit on their 1929 cost.
- Words to Live By – The Better Letter
- Low Expectations – M. Housel
- The Dangers of Averaging Down – Safal Niveshak
- Don’t Trust Management Forecasts – Klement on Investing
- Do Commodities Have a Place in Your Portfolio? – B. Johnson
- Commodities vs commodity ETFs – ETF Stream
- Morgan Housel: The Psychology of Money, Picking the Right Game, and the $6 Million Janitor (podcast) – Tim Ferriss Show
- Adversarial Collaboration: An EDGE Lecture by Daniel Kahneman – Edge
- Endurance: Shackleton’s lost ship is found in Antarctic – BBC