Walter Schloss’s 16 Lessons for Investing
Rules for Value Investing
Walter Jerome Schloss (1916 -2012) was an American investor, Fund Manager and Philanthropist.
He did not attend college and was initially hired at the age of 18 as a runner on Wall Street in 1934. He took investment courses taught by Graham at the New York Stock Exchange Institute. He eventually went to work for Graham in the Graham-Newman Partnership, at about the same time Warren Buffett worked in the firm.
In 1955, Schloss left Graham's company and started up his own investment firm, eventually managing money for 92 investors. By maintaining a manageable asset size, Schloss averaged a 15.3% compound return over the course of five decades, versus 10% for the S&P 500. Schloss closed out his fund in 2000 and stopped actively managing others' money in 2003.
Warren Buffet mentioned Schloss in his classic essay “The Superinvestors of Graham and Doddsville”
This is a sublime piece and should be read all serious investors. It was based on a talk given by Buffett at the Columbia University in a debate on the Efficient Market Hypothesis (EMH). Professor Michael C Jensen argued in favour of EMH while Buffett argued against EMH.
Buffett had this to say about Schloss:
He knows how to identify securities that sell at considerably less than their value to a private owner: And that's all he does. He owns many more stocks than I do and is far less interested in the underlying nature of the business; I don't seem to have very much influence on Walter. That is one of his strengths; no one has much influence on him.
Schloss and Buffett both studied at Benjamin Graham’s evening class at the Columbia. Graham’s mantra was to by a very large very diversified portfolio of statistically cheap stocks. Graham had lost heavily in the 1929 crash and , as a result put great emphasis on the “Margin Of Safely” when selecting stocks.
Graham advocated the net-net value investing strategy. This focused on net current asset value per share (NCAVPS) as the primary measure to evaluate the merits of a stock. This ignores long-term assets or liabilities. Graham argued that investors should buy stock where the price per share is at a significant discount to NCAVPS. Ideally, the discount should be at least 33%. If the NCAVPS is US$ 10 , the investors should not buy the stock unless it trades at a price of US$ 6.70 or below.
This is belt and braces approach. First it ignores long-term assets completely in calculating the value of the company. Secondly it then demands a 33% discount to that valuation.
In addition, since this strategy does not always work, Graham advocated extreme diversification and often has a portfolio which consisted of hundreds of stocks.
This strategy just looks at one statistical formula derived from the Balance sheet and does not require any qualitative knowledge of the business of the company. One needs much more knowledge of the underlying business of the company is one is going to try and value it on the basis of future earnings
This was sometimes called “cigar butt” investing. You find a discarded cigar butt on the road which is still smoking – you take a couple of puffs on it – it is not much of a smoke but you paid nothing for it.
Buffet followed the Graham approach strategy but gradually moved away from this from about 1966 as his asset under management (aum) increased significantly ( Graham approach tended to select small companies) and he became aware of the deficiencies of the Graham approach.
Buffet gradually moved towards the ideas of Philip Fisher under influence of Munger
The Munger-Fisher approach can be characterised as “buy a very select number of good quality companies at fair prices.” In contrast the Graham approach is “buy a large number of small companies at very low prices irrespective of their quality.”
Schloss at his peak only had 92 clients and his assets were a tiny fraction of those managed by Buffet. He stuck much closer to the Graham approach throughout investing approach. He once summarised his philosophy as buying cheap stocks.
His investing rules noted below need to be seen in the light of this.
These are 16 golden rules for investing from Walter Schloss.
1. Price is the most important factor to use in relation to value
2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.
3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).
4. Have patience. Stocks don’t go up immediately.
5. Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.
6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.
7. Have the courage of your convictions once you have made a decision.
8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
9. Don’t be in too much of a hurry to see if the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high. If the stock market historically high. Are people very optimistic etc?
10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 yeas before the stock sold at 20 which shows that there is some vulnerability in it.
11. Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.
12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.
13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with purchase and sale of stocks.
14. Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return in percentage terms divided into 72 will tell you the number of years to double your money.
15. Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
16. Be careful of leverage. It can go against you.