At the age of 82, legendary investor Martin Whitman is still going strong; his mind is still as sharp as ever. Since founded Third Avenue Value Fund (TAVF) at the age of 65, his fund has returned more than 16% a year over the past 17 years.
What attributes does Martin Whitman look in an investment? “Safe and Cheap!” To understand how he invests, we strongly recommend you to read his quarter shareholder letters. Reading his letter may not be as relaxed as reading Warren Buffett letters, but you will learn just as much, if not more.
These are a summary of what he looks in an investment?
Safety First
According to Martin Whitman, the "safe and cheap" investor looks for four things in an investment:
High quality balance sheet;
Competent and shareholder-oriented management;
Understandable and honest disclosure documents;
Priced at 50 to 60 cents on a dollar.
The first three is related to how safe an investment is. The fourth relates to how cheap the stock is. And "safe" is more important than "cheap".
Assets Over Earnings
The first thing Martin Whitman wants is a "safe" balance sheet featuring high-quality assets, the absence of liability and the presence of cash. Without these, he doesn't even consider the common stock.
Whitman believes that scrutinizing the balance sheet is easier than trying to forecast earnings and predict stock market gyrations. Most investors are outlook-conscious. He is price-conscious. He hones his easy way of measuring price, quantity and quality. Everything is in the balance sheet - the only way you know whether you've covered all the bases is to look at the lists of assets and liabilities.
To Martin Whitman, balance sheets are much more important than the income statement. He believes that security analysis would be simpler if one focuses on the balance sheet while placing no emphasis on the income statement and earnings estimates.
Martin Whitman thinks that earnings and earnings power are vastly overrated. In his book, Value Investing: A Balanced Approach, he advises businessmen not to treat one accounting number, such as the bottom line, as more important than another. They are all part of the whole picture. Besides, profits are may be viewed as the least desirable way to create wealth because of the income-tax disadvantage. It's a lot easier to look at the quantity and quality of the assets and resources that a company has than to forecast its earnings. Assets can appreciate in value, can be enhanced, sold, or converted into something more productive.
With more than $13 billion under management, Martin Whitman still considers himself as an outside passive minority investor (OPMI). He said the key to OPMI is to avoid risks. These are the excerpt from his latest shareholder letter on how to avoid risks in investments as an outside passive minority investor. 1. Buy Cheap.
Martin Whitman: Warren Buffett, the Chairman of Berkshire Hathaway, describes his investment technique as trying to buy good companies at reasonable prices. Warren, however, is a control investor, and while a reasonable price standard has worked remarkably well for Berkshire Hathaway, that standard is not good enough for TAVF, an OPMI. The Fund has to try to buy at bargain prices, i.e., cheap. The definition of “cheap” for TAVF in acquiring common stocks in the vast majority of cases is acquiring issues at prices that reflect substantial discounts from readily ascertainable NAVs. Further, the Fund acquires such NAV common stocks only when Fund management believes that the prospects are reasonable that over the long term such NAVs will increase by not less than 10% per year compounded. Common stock holdings which met these standards when acquired by the Fund include Toyota Industries, Forest City Enterprises, Brookfield Asset Management, Cheung Kong Holdings, Posco and Wheelock.
I doubt very much if those discount prices would have existed if any of those issues were likely to be subject to a change of control. That type of cheapness is one of the advantages of being an OPMI. Readily ascertainable NAVs means that the Third Avenue common stock portfolio is, to a large extent, concentrated in financial institutions and companies involved with income-producing real estate. Third Avenue’s portfolio contains almost no common stocks of companies engaged in old-line manufacturing.
Control investors can afford to pay up versus TAVF because control investors are in a position to undertake financial engineering, and to cause management changes. Third Avenue leaves companies as-is, and places particular efforts into buying into well-managed businesses with stable, but clearly superior, managements. This seems to have been achieved in establishing relatively large positions in the companies mentioned in the previous paragraph, as well as in acquiring large positions in Nabors Industries, Power Corp., St. Joe and Mellon Financial.
2. Buy Equity Interests Only in High Quality Businesses.
Martin Whitman: The Fund does not knowingly acquire the common stock of any company unless that company enjoys a super strong financial position. TAVF tries to buy into reasonably well-managed companies. Fund management appreciates the fact that any relationship between OPMIs and corporate managements combine communities of interests and conflicts of interest; Third Avenue Management tries to restrict itself to situations where the communities of interest seem to outweigh the conflicts of interest. Third Avenue restricts its common stock investments to companies whose businesses are understandable to Fund management and where there exists full documentary disclosure, including audited financial statements.
3. TAVF tries to operate on a low cost basis for its shareholders.
Martin Whitman: The fiscal 2006 expense ratio was 1.08%. Third Avenue has no 12-b(1) charges, is a no-load fund and imposes no redemption fees on long-term shareholders. Since portfolio turnover is low, transaction, i.e., trading, costs, too, are low.
4. The Fund ignores market risk.
Martin Whitman: Fluctuations in market prices are mostly a random walk with changes in market prices not in any way a measure of long-term investment risk, or investment potential. It is as Ben Graham used to say, “In the short run the market is a voting machine. In the long run the market is a weighing machine.” Most competent control investors, again like Warren Buffett, pretty much ignore market risk also in that little, or no, weight is given to daily, or even annual, marks to market for portfolio holdings.
5. Buy growth, but don’t pay for it.
Martin Whitman: In the financial community, growth is a misused word. Most market participants don’t mean growth, but rather, mean generally recognized growth. In so far as growth receives general recognition, a market participant has to pay up. To my mind, Cheung Kong Holdings, Forest City Enterprises, Covanta and Toyota Industries are growth companies. When the common stocks were acquired, none of these issues enjoyed general recognition as having growth potential.
6. TAVF is a buy-and-hold investor.
Martin Whitman: Although our entry point into a common stock is a bargain price, the Fund will continue to hold a security where Fund management believes that the business has reasonable prospects that it can, over the long run, increase annual NAV by a double digit number; and where Fund management does not believe it made a mistake. Mistakes are measured by beliefs that there has occurred a permanent impairment in underlying value or financial position. The Fund will also sell if there is a belief that the security is grossly overpriced. Finally, the Fund will sell for portfolio considerations; i.e., where there are massive enough redemptions of Fund shares so that the liquidity of the Fund is threatened. As one can see by our sales activity during the quarter, most of our sales occur when a company is taken over.
7. The Fund does not borrow money and, thus, invests without financial leverage.
Martin Whitman: Furthermore, the TAVF portfolio has a cash cushion. Usually 10% to 20% of Fund assets are in cash or credit instruments without credit risk.
What attributes does Martin Whitman look in an investment? “Safe and Cheap!” To understand how he invests, we strongly recommend you to read his quarter shareholder letters. Reading his letter may not be as relaxed as reading Warren Buffett letters, but you will learn just as much, if not more.
These are a summary of what he looks in an investment?
Safety First
According to Martin Whitman, the "safe and cheap" investor looks for four things in an investment:
High quality balance sheet;
Competent and shareholder-oriented management;
Understandable and honest disclosure documents;
Priced at 50 to 60 cents on a dollar.
The first three is related to how safe an investment is. The fourth relates to how cheap the stock is. And "safe" is more important than "cheap".
Assets Over Earnings
The first thing Martin Whitman wants is a "safe" balance sheet featuring high-quality assets, the absence of liability and the presence of cash. Without these, he doesn't even consider the common stock.
Whitman believes that scrutinizing the balance sheet is easier than trying to forecast earnings and predict stock market gyrations. Most investors are outlook-conscious. He is price-conscious. He hones his easy way of measuring price, quantity and quality. Everything is in the balance sheet - the only way you know whether you've covered all the bases is to look at the lists of assets and liabilities.
To Martin Whitman, balance sheets are much more important than the income statement. He believes that security analysis would be simpler if one focuses on the balance sheet while placing no emphasis on the income statement and earnings estimates.
Martin Whitman thinks that earnings and earnings power are vastly overrated. In his book, Value Investing: A Balanced Approach, he advises businessmen not to treat one accounting number, such as the bottom line, as more important than another. They are all part of the whole picture. Besides, profits are may be viewed as the least desirable way to create wealth because of the income-tax disadvantage. It's a lot easier to look at the quantity and quality of the assets and resources that a company has than to forecast its earnings. Assets can appreciate in value, can be enhanced, sold, or converted into something more productive.
With more than $13 billion under management, Martin Whitman still considers himself as an outside passive minority investor (OPMI). He said the key to OPMI is to avoid risks. These are the excerpt from his latest shareholder letter on how to avoid risks in investments as an outside passive minority investor. 1. Buy Cheap.
Martin Whitman: Warren Buffett, the Chairman of Berkshire Hathaway, describes his investment technique as trying to buy good companies at reasonable prices. Warren, however, is a control investor, and while a reasonable price standard has worked remarkably well for Berkshire Hathaway, that standard is not good enough for TAVF, an OPMI. The Fund has to try to buy at bargain prices, i.e., cheap. The definition of “cheap” for TAVF in acquiring common stocks in the vast majority of cases is acquiring issues at prices that reflect substantial discounts from readily ascertainable NAVs. Further, the Fund acquires such NAV common stocks only when Fund management believes that the prospects are reasonable that over the long term such NAVs will increase by not less than 10% per year compounded. Common stock holdings which met these standards when acquired by the Fund include Toyota Industries, Forest City Enterprises, Brookfield Asset Management, Cheung Kong Holdings, Posco and Wheelock.
I doubt very much if those discount prices would have existed if any of those issues were likely to be subject to a change of control. That type of cheapness is one of the advantages of being an OPMI. Readily ascertainable NAVs means that the Third Avenue common stock portfolio is, to a large extent, concentrated in financial institutions and companies involved with income-producing real estate. Third Avenue’s portfolio contains almost no common stocks of companies engaged in old-line manufacturing.
Control investors can afford to pay up versus TAVF because control investors are in a position to undertake financial engineering, and to cause management changes. Third Avenue leaves companies as-is, and places particular efforts into buying into well-managed businesses with stable, but clearly superior, managements. This seems to have been achieved in establishing relatively large positions in the companies mentioned in the previous paragraph, as well as in acquiring large positions in Nabors Industries, Power Corp., St. Joe and Mellon Financial.
2. Buy Equity Interests Only in High Quality Businesses.
Martin Whitman: The Fund does not knowingly acquire the common stock of any company unless that company enjoys a super strong financial position. TAVF tries to buy into reasonably well-managed companies. Fund management appreciates the fact that any relationship between OPMIs and corporate managements combine communities of interests and conflicts of interest; Third Avenue Management tries to restrict itself to situations where the communities of interest seem to outweigh the conflicts of interest. Third Avenue restricts its common stock investments to companies whose businesses are understandable to Fund management and where there exists full documentary disclosure, including audited financial statements.
3. TAVF tries to operate on a low cost basis for its shareholders.
Martin Whitman: The fiscal 2006 expense ratio was 1.08%. Third Avenue has no 12-b(1) charges, is a no-load fund and imposes no redemption fees on long-term shareholders. Since portfolio turnover is low, transaction, i.e., trading, costs, too, are low.
4. The Fund ignores market risk.
Martin Whitman: Fluctuations in market prices are mostly a random walk with changes in market prices not in any way a measure of long-term investment risk, or investment potential. It is as Ben Graham used to say, “In the short run the market is a voting machine. In the long run the market is a weighing machine.” Most competent control investors, again like Warren Buffett, pretty much ignore market risk also in that little, or no, weight is given to daily, or even annual, marks to market for portfolio holdings.
5. Buy growth, but don’t pay for it.
Martin Whitman: In the financial community, growth is a misused word. Most market participants don’t mean growth, but rather, mean generally recognized growth. In so far as growth receives general recognition, a market participant has to pay up. To my mind, Cheung Kong Holdings, Forest City Enterprises, Covanta and Toyota Industries are growth companies. When the common stocks were acquired, none of these issues enjoyed general recognition as having growth potential.
6. TAVF is a buy-and-hold investor.
Martin Whitman: Although our entry point into a common stock is a bargain price, the Fund will continue to hold a security where Fund management believes that the business has reasonable prospects that it can, over the long run, increase annual NAV by a double digit number; and where Fund management does not believe it made a mistake. Mistakes are measured by beliefs that there has occurred a permanent impairment in underlying value or financial position. The Fund will also sell if there is a belief that the security is grossly overpriced. Finally, the Fund will sell for portfolio considerations; i.e., where there are massive enough redemptions of Fund shares so that the liquidity of the Fund is threatened. As one can see by our sales activity during the quarter, most of our sales occur when a company is taken over.
7. The Fund does not borrow money and, thus, invests without financial leverage.
Martin Whitman: Furthermore, the TAVF portfolio has a cash cushion. Usually 10% to 20% of Fund assets are in cash or credit instruments without credit risk.
