Many of you would know Warren Buffett as a billionaire investor and father of value investing. Over the past decade, many have written articles, books, interviews on Buffett’s approach to investing.
Due to Buffett’s overwhelming success and popularity, the work of other value managers becomes relatively unknown beyond the value camp. One investor in particular; a staunch practitioner of Graham’s version of conservative value investing and did not evolve into more of a qualitative investor like Buffett.
Worked with Buffett at Graham Newman Partnership as a Securities Analyst, Walter Schloss went on to manage an investment partnership from 1955 to 2002 which returned 16% per annum after fees, beating the 10% annual return generated by the S&P 500 in the same period.
Walter Schloss was one of the “superinvestors” that Buffett talked about in “The Superinvestors of Graham and Doddsville”, a paragraph taken from the essay briefly describes his approach to investing:
“Walter has diversified enormously, owning well over 100 stocks currently. 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 doesn’t worry about whether it’s January, he doesn’t worry about whether it’s Monday, he doesn’t worry about whether it’s an election year. He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over again. He owns many 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’s one of his strengths; no one has much influence on him.”
Just like Buffett in his early days, Walter Schloss was a classic deep value investor with an emphasis on asset-backed valuations.
Walter’s strategy was to look for stocks that were discounted to its book value, low debt levels, and high insider ownership. He would also be looking for beaten-down stocks that are trading near its 52 weeks lows, trading at low P/E multiples and ideally stocks that have been around for 10 years.
In 1994, Walter Schloss revealed and shared his insights on stock picking to serve as a guide to newer investors or those without in-depth knowledge of the value investing process. He listed 16 factors that one needs to make money in the stock market.
The 16 Factors for Investing Success
The 16 factors for investing success as stated by Walter Schloss:
- Price is the most important factor to use in relation to value.
- 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.
- 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.
- Have patience. Stocks don’t go up immediately.
- Don’t buy on tips or for a quick move. Let the professionals do that if they can. Don’t sell on bad news.
- 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 weaknesses in your thinking. Buy on a scale and sell on a scale up.
- Have the courage of your convictions once you have made a decision.
- Have a philosophy of investment and try to follow it.
- Don’t be in too much of a hurry to sell. 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 reevaluate 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?
- 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’s attractive. Three years before the stock sold at 20 which shows that there is some vulnerability in it.
- Try to buy assets at a discount rather than buying earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings.
- 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.
- Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
- Remember the word compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in six years, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
- Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
- Be careful of leverage. It can go against you. (For related insight, read more about the value in value investing.)
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Walter did not depend on information given by others to make investment decisions, his greatest strength was the ability to think independently. He would spend a lot of time looking for ‘Cigar Butt’ stocks or companies that are trading at discount to net working capital.
“He has no connections or access to useful information. Practically no one on Wall Street knows him and he is not fed any ideas. He looks up the numbers in the manuals and sends for the annual reports, and that’s about it.” – The Superinvestors of Graham and Doddsville.
Walter ensures that his portfolio is well diversified up to 100 stocks and a single position in a company never accounted for more than 20% of his portfolio.
Walter believed that investing should be stress-free and not worry, it should be fun and challenging. His advice was to understand one’s strength and weaknesses and develop a simple strategy to suit an individual’s tolerance for risk.
Unlike Buffett who once said “Diversification is protection against ignorance”, Walter was a strong proponent for diversifying stocks. He knew that diversification would be more suited to his own personality, he said:
“I always held 50 to 100 at any given time because it would have been very stressful if one particular stock had turned against me. Psychologically, I am just built differently from Warren. I see that there are many people trying to be like Warren, but they should take note that he is not only a good analyst; he is also a good judge of people and businesses. I know my limitations, so I’d rather invest in the way I am most comfortable with.” Source: The Value Investors: Lessons from the World’s Top Fund Managers
Schloss’s strategy may be simplistic, but they were fundamental in building one of the greatest track records in the history of stock investing. Walter Schloss had a one-room office that was located inside the offices of Tweedy Brown, a much larger investment manager. He never used a computer or a fancy Bloomberg terminal to find his investment ideas. He didn’t rely on complicated algorithms or complex quantitative finance theories. He didn’t talk to corporate management as he preferred to focus on the numbers and data when evaluating a company for investment.
Walter Schloss’s approach to investing is certainly a good stepping stone in achieving consistent and sustainable returns. We as retail investors are more like Walter Schloss than Warren Buffett, Walter wasn’t blessed with good business acumen or a good judge of people but he excelled through discipline and patience. Importantly, we should understand our personalities better than anyone else and take advantage of our strengths. We shouldn’t try to be someone who we are not.