Value Investing with Walter Schloss

One of the reasons I started a value investing blog on Walter Schloss, Irving Kahn, early Warren Buffett and other members of the Graham-Newman Corporation was my fascination on how rare their early investment style is still applied today.  I think we can all agree that finding 2/3 net/nets as Ben Graham prescribed is difficult.  That being said, far too often we hear about GARP or EV/EBITDA versus as asset based approach so effectively employed by Walter Schloss.

In 1985, Barron’s ran a story entitled “The Right Stuff: Why Walter Schloss is Such a Great Investor.”  You can find a link to the piece in our value investing resources page.  In this post, like one of our earlier Walter Schloss posts on the blog, I will be using bullet points to document my notes.

• Interesting point about how Barron’s had not heard of Walter Schloss until Warren Buffett blew his cover in the ever famous “The Superinvestors of Graham-And-Doddsville”
• Walter recounts how he got into the business.  It is interesting to note that in this interview, he says “Graham was writing his book on the stock market, and I remember helping him with one chapter.” I never knew that part of the story – this is all before Schloss had enlisted.
• Very heartily recommends The Intelligent Investor
• Compares Ben Graham to an undervalued security: “It’s a funny thing about Graham. I think he was like an undervalued security, if you want to know. People said, ‘Oh, Ben Graham, he’s very smart.’ But then they’d go off and do their own little thing with computers, or whatever the popular thing was at the moment.  They kind of forgot. They’d say ‘Oh, we like undervalued stocks,’ but then they wouldn’t buy them.”  He then goes on to point out that Graham’s ideas made perfect sense to him.
• Ben Graham’s philosophy on buying a diversified pool of stocks stems from the pain he experienced during the Great Depression.
• At Graham Newman they followed “the idea of buying companies selling below working capital – at two thirds of working capital – then, when the stocks’ prices went up to match working capital per share, we’d have made 50% on our money. And the firm averaged about 20% a year on that basis.”  Schloss, like I noted above, then goes on to note that during the fifties, those stocks started disappearing.
• Why did these stocks trade at these levels previously? “They were mostly secondary companies; they were never the top grade companies.  And they tended to be ignored by the public because they didn’t have any sex appeal, there wasn’t any growth – there was always trouble with them.  You were buying trouble when you bought these companies, but you were buying them cheap. Of course, when you got them too cheap, they maybe ended up going down the tubes. So you try to be a little careful. But people don’t like to buy things that are going down.”
• Philosophy: “Graham liked the idea of protection on the downside and basically, that’s what I do. I try not to lose money.”
• When asked what he think the market will do, his response: “I’ve got no idea; your guess is as good as mine.”
• Schloss on timing: “Timing is a very – everybody tries to do it, so I stay away from the game that everyone’s trying to do. If you buy value – and you may buy it too soon, as undoubtedly I do – then if it goes lower; you buy more.  You have to have confidence in what you are doing.”
• Again using five years as a yardstick.  But notes their average holding period is 4 years.
• Liked to stay under the radar.
• On his investing style: “I am a passive investor.  There are people who try to be very aggressive; they try to buy companies [Editor Note: Remember this is during the LBO Boom of the mid to late 80s]. We just buy the stock, and if it goes to what we think is a reasonable price, we sell it and move on to something else. Graham made the point in his book where he said, ‘You buy stocks like you buy groceries, not like you buy perfume.’ You’re looking for value.”
• No ticker tape machine in his office – he tries to stay away from the emotions of the market. The market appeals to fear and greed – He doesn’t want to be a part of that.
• Blames Warren Buffett for the uprise in value investing and how hard it is to buy cheap stocks.
• Gives an anecdote about a stock that Schloss purchased for the fund and then the company was bought out shortly thereafter: “But the point is, if it hadn’t worked out that way, Stauffer was a really good company, and in a few years it would have worked out satisfactory.  It happened to work out quicker, that’ all.”
• Doesn’t like short term gains.
• On the insert lists the rationale’s for a number of his stock picks:
  • “The downside is limited…so you buy it”
  • It isn’t exactly cheap. But it’s a good value.”
  • “Basically a good company and there will be another deal”
  • “It does have problems. I can’t say that enough.”
  • “The timber is worth a lot more than the market price.”
  • “You couldn’t replace it for what it sells for.” (On Texaco)
  • “A good value stock. They had a terrible break.”
  • “There’s no particular point selling it. I have a big profit.”
  • “It’s got a lot of cash flow”
• Note that he was managing $45M in 1987
• Notes that Graham returned a substantial amount of his limited partners capital when he couldn’t find cheap stocks in 53′.
• On portfolio management: “The thing is, we don’t put the same amount in each stock. If you like something like Northwest Industries, you put a lot of money in it. But we may buy a little bit of stock, to get our feet wet, and get a feeling for it. Sometimes if you don’t own a stock, you don’t pay enough attention.  Then also, we sell stock on scale. Sometimes we sell some, and then stock poops out on us, and then we’re stuck.”
• Continuing: “Sometimes we get into situations where we really don’t sell at all. So we have more securities than I’d like to have, and yet, I feel comfortable owning them. Then, of course, you get a situation where you buy the stock, and it seems a good value, and it goes up a fair amount, and you like it better. You become a little more attached to it, and then you see some pluses that you may not have realized before.”
• The quote above confuses me: Does he mean you like the stock because it has gone up or because you’ve done more work on it and got lucky with the price action?
• Adjusted Working Capital = Current Assets – Current Liabilities – Debt
• Again notes about management holding stock – seems to be very import to Walter Schloss
• Talk about analyzing the balance sheet: “And of course a lot of companies have lots of assets tied up in plant and equipment. Well is it an old plant, or is it a new plant?
• “You don’t have to just look at book value. You can look at what you think companies are worth, if sold. Are you getting a fair stake for your money?”
• Talks about a “good company” and dubs it a “not a book value stock.”  (For reference, the company was selling at 10x earnings, 5.5% dividend yield, 1.5x book, 15% ROE)
• Here is a very interesting quote (probably my favorite in this article): When asked why “park money” in a stock: “If the market was very low, I’d say ‘Well, CPC probably isn’t a great stock to own. If the market is so cheap, you want something with a little more zip in it, or potential.’  In a market like ours, which is not very cheap – I wouldn’t say its way overpriced, because it isn’t; it’s in a more reasonable area-there’s more risk on the downside. CPC probably doesn’t have that much downside risk, and therefore I feel comfortable with it. If the market should collapse, we, then maybe we’d sell it, assuming we’d be getting that price, and buy something that’d gone down a lot.”
• Notes how he doesn’t get involved in looking at earnings potential.
• Why difficult to sell?  Upward price movements feed on themselves …
• On holding cash: “We’ve never really done that. We’ve always been fully invested.  Which may be good, and may not be good – it’s psychological.  I find I’m more comfortable being fully invested than I am sitting with cash.” …very different from a number of Value Investing Legends…
• Note he doesn’t play in options, doesn’t write covered calls, doesn’t short stocks
• Noted that Graham thought when there were no working capital stocks, the market was overvalued…Schloss does not that theory does not really apply anymore.
• Schloss on the market: “I simply say, if there are not too many value stocks that I can find, the market isn’t all that cheap.”

Simply incredible.  Stay tuned later in the week when we explore more value investing articles on Walter Schloss and start digging into some securities.