In November 1993, Columbia Business School had the chance to listen to Walter Schloss share on value investing. I think it would be useful to share some key ideas of the talk here.
Benjamin Graham often took companies that appeared close to each other in the alphabet order to compare them statically. He didnât look for franchise value or management. The reason Ben used this method was that he didnât want to lose money; he didnât want to go through a rough time like the Great Depression again. The only problem with this thinking was that investors canât capture the total profit potential. When the stock went up to what appeared to be reasonable price, it would be sold because the growth in the portfolio was limited.
Walter Schloss never put the stop loss order. If it went down further, he might buy more if he could afford to. He found it very difficult to buy a stock that had gone up after being bought in. For management, Walter didnât think he could go out and talk to management. Thatâs why he preferred to stick to passive investing and owning a number of stocks. He knew what he was doing and he knew what he didnât know.
âWarren Buffett is happy with owning a few stocks and he is right if heâs Warren but when you arenât, you have to do it the way thatâs comfortable for you and I like to sleep nights. When you are managing the other fellowsâ money, it is important not to get sick over it.â
The other reason that Walter stressed the downsize protection was he managed the open-end fund. As he explained:
âEach year starts January 2 and ends on December 31. This means that if you were fortunate enough to buy a stock at $10 and find it at $20. At the year end, you had the great year with the big unrealized profit but beginning on a new year, you are starting at $20. If at the end of the second year, the stock is at $15, you have lost 25% of the stock holders money that year, if that were your only holding. For the investor who bought in at the beginning of the second year, he will be very unhappy and may liquidate his holdings. If enough people do this, you wonât have the company.â
That might be the reason the model of Berkshire Hathaway had been set up by Buffett very rationally by two factors:
Ă By having insurance companies, Buffett can use stocks as well as bonds as reserves. By having large reserves he doesnât have to pay dividends.
Ă By keeping all the earnings, Berkshire could reinvest its profits and compound the investment results. Buffett didnât have to worry about investors redeeming their shares. If the market collapsed and Berkshireâs stock went down 30 percent, which it had done several times, no one could redeem their shares.
Like Warren, he agreed to keep things simple and not use higher maths in the analysis. The simple checklist of Walter was as follows:
Ă What kind of stocks do we look at? We look for stocks that are depressed.
Ă Why are they depressed?
Ă Are they selling below book value?
Ă Is goodwill in book value?
Ă What is high and low over the last 10 years?
Ă Any cash flow?
Ă Any net income earned?
Ă How have the company done over the last 10 years
Ă What kind of industry that the business is in?
Ă Howâs the profit margin?
Ă How are the competitors? And the comparison with their competitors?
Ă What seems to be the downsize risk and upside potential?
Ă Insider ownership?
If this checklist was scanned through and a stock was identified, he would take the initial position. Then he would watch the action of stock and decide how much he might want. The holding could vary from 5% to 10-12% per position. The average total number of stocks in his portfolio is 60-70.
Benjamin Graham often took companies that appeared close to each other in the alphabet order to compare them statically. He didnât look for franchise value or management. The reason Ben used this method was that he didnât want to lose money; he didnât want to go through a rough time like the Great Depression again. The only problem with this thinking was that investors canât capture the total profit potential. When the stock went up to what appeared to be reasonable price, it would be sold because the growth in the portfolio was limited.
Walter Schloss never put the stop loss order. If it went down further, he might buy more if he could afford to. He found it very difficult to buy a stock that had gone up after being bought in. For management, Walter didnât think he could go out and talk to management. Thatâs why he preferred to stick to passive investing and owning a number of stocks. He knew what he was doing and he knew what he didnât know.
âWarren Buffett is happy with owning a few stocks and he is right if heâs Warren but when you arenât, you have to do it the way thatâs comfortable for you and I like to sleep nights. When you are managing the other fellowsâ money, it is important not to get sick over it.â
The other reason that Walter stressed the downsize protection was he managed the open-end fund. As he explained:
âEach year starts January 2 and ends on December 31. This means that if you were fortunate enough to buy a stock at $10 and find it at $20. At the year end, you had the great year with the big unrealized profit but beginning on a new year, you are starting at $20. If at the end of the second year, the stock is at $15, you have lost 25% of the stock holders money that year, if that were your only holding. For the investor who bought in at the beginning of the second year, he will be very unhappy and may liquidate his holdings. If enough people do this, you wonât have the company.â
That might be the reason the model of Berkshire Hathaway had been set up by Buffett very rationally by two factors:
Ă By having insurance companies, Buffett can use stocks as well as bonds as reserves. By having large reserves he doesnât have to pay dividends.
Ă By keeping all the earnings, Berkshire could reinvest its profits and compound the investment results. Buffett didnât have to worry about investors redeeming their shares. If the market collapsed and Berkshireâs stock went down 30 percent, which it had done several times, no one could redeem their shares.
Like Warren, he agreed to keep things simple and not use higher maths in the analysis. The simple checklist of Walter was as follows:
Ă What kind of stocks do we look at? We look for stocks that are depressed.
Ă Why are they depressed?
Ă Are they selling below book value?
Ă Is goodwill in book value?
Ă What is high and low over the last 10 years?
Ă Any cash flow?
Ă Any net income earned?
Ă How have the company done over the last 10 years
Ă What kind of industry that the business is in?
Ă Howâs the profit margin?
Ă How are the competitors? And the comparison with their competitors?
Ă What seems to be the downsize risk and upside potential?
Ă Insider ownership?
If this checklist was scanned through and a stock was identified, he would take the initial position. Then he would watch the action of stock and decide how much he might want. The holding could vary from 5% to 10-12% per position. The average total number of stocks in his portfolio is 60-70.
