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Walter Schloss: The Essence of Value Investing

July 07, 2011
Here are some notes taken from the life of Walter Schloss, once an office roommate of Warren Buffett. He is still alive and kicking at 95, and is one of the investors who inspires me the most. He had several points in common with Philip Fisher and Philip Carret, some of his contemporary investing legends; they lived very long; invested since very young until late in life; and never looked for extreme fortune or fame. He also led a simple life and, until recent interviews, still invests his personal money. His life incarnates the essential substance of value investing.

Let's start by what Warren Buffett had this to say about Schloss:

Walter 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.

Walter did not go to business school, or for that matter, college. His office contained one file cabinet in 1956; the number mushroomed to four by 2002. Walter worked without a secretary, clerk or bookkeeper, his only associate being his son, Edwin, a graduate of the North Carolina School of the Arts. Walter and Edwin never came within a mile of inside information. Indeed, they used “outside” information only sparingly, generally selecting securities by certain simple statistical methods Walter learned while working for Ben Graham. When Walter and Edwin were asked in 1989 by Outstanding Investors Digest, “How would you summarize your approach?” Edwin replied, “We try to buy stocks cheap.” So much for Modern Portfolio Theory, technical analysis, macroeconomic thoughts and complex algorithms.

Following a strategy that involved no real risk – defined as permanent loss of capital – Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500. It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success. It’s safe to say that had millions of investment managers made trades by a) drawing stock names from a hat; b) purchasing these stocks in comparable amounts when Walter made a purchase; and then c) selling when Walter sold his pick, the luckiest of them would not have come close to equaling his record. There is simply no possibility that what Walter achieved over 47 years was due to chance.


Schloss did not attend college. He was hired at the age of 18 in 1934 as a runner on Wall Street. He took investment courses taught by Graham at the New York Stock Exchange Institute. Among his classmates was Gus Levy, the future chairman of Goldman Sachs (GS). He eventually went to work for the Graham-Newman Partnership. He worked for Ben Graham for almost 10 years. He employed Graham’s emphasis on capital preservation. They invested in small, unknown companies, in bankrupt bonds and arbitrage. He looked at companies selling below working capital. In 1955, he left Graham to start his own firm, starting with a handful of investors and a few thousand dollars and eventually managing money for close to 100 investors. By maintaining a manageable asset size, Schloss averaged a 15.3% (20.9% pre-fees) 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 to exclusively oversee his own multi million-dollar portfolio.

Here is how Warren Buffett once described Walter's investment method:

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 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 and over again.

By 72 years, still "young", he summed up his passion for investing,“At my age, most people want to retire to Florida and play tennis and relax. But I get a great deal of pleasure from what I do.”. By the age of 80, Schloss hadn’t changed, according to Buffett’s biography, The Snowball: Walter Schloss still lived in a tiny apartment and picked stocks the same way he’d always done.

Walter Schloss lived through 17 recessions, starting with one when Woodrow Wilson was President. He made money through many of them. Does he try to see where the economy is going? No, he doesn't worry about it. His energy is focused towards finding cheap companies during any market period, specially if the market is depressed.

Schloss has a laid-back approach that current traders do not comprehend. He never owned a computer and gets his prices from the morning newspaper. His financial data come from company reports delivered to him by mail, or from copies of Value Line, the stock information service. His work hours when he was running his fund were from 9:30 a.m. to 4:30 p.m.

As a manager after leaving Graham, he started a hedge fund. He charged no management fee but took one quarter of profits. He ran his business with no research assistants, no secretary. He and his son, Edwin (who joined him in 1973), worked in a single room, in a small New York appartment, with Value Line charts and tables.

In a famous 1984 speech titled the "The Superinvestor of Graham-and-Doddsville," Buffett said Schloss was a flesh-and-blood refutation of the Efficient Market Theory. Asked whether he considers himself a superinvestor, Schloss demurs:"Well, I don't like to lose money. We just try to buy cheap stocks. That’s really all. We try to buy things that are out of favor – stocks that others don’t want."

Like all investors who do what’s supposedly impossible and beat the market, Walter Schloss had his rules. In 1994 he typed them up onto a single sheet of paper – 16 bullet point guidelines.

Factors needed to make money in the stock market:

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 the 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 you are correct in your judgement. 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.
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 sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock a 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? Is 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. Three years before the stock sold at 20 which shows there is some vulnerability to it.
11 - Try to buy assets at a discount [rather] than to buy 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.
12 - Listen to suggestions from people you respect. This does not 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 judgement. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
14 - Remember the work of 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 [divided] into 72 will tell you the number of years to double your money.
15 - Prefer stocks over bonds. Bonds will limit your gains and inflation will limit your purchasing power.
16 - Be careful of leverage. It can go against you.
It sounds simple but it is difficult to put in practice due to the difficulty to control emotions.

He has a Depression-era mentality that benefited clients. His wife, Anna, jokes that he trails her around their home turning off lights to save money. If prodded, he'll detail for visitors his technique for removing uncanceled stamps from envelopes. The Value Line sheets are from his son, who has a subscription. "Why should I pay?" Schloss says.

To work Schloss picks up a Value Line booklet and runs his index finger across a line of numbers, spitting out the ones he likes: stock trading at 80% of book value, a 3% dividend yield, no debt."Most people say, 'What is it going to earn next year?' I do not care much about earnings as long as they are reasonable, I focus on assets. If you don't have a lot of debt, it's worth something." The market will always offer certain securities that are undervalued, but the best time to look for them is when there's panic and fear on Wall Street. Schloss elaborates:

I would suggest that investors be very careful what they buy. I don't like debt (emphasis added). What I usually looked for companies that were having troubles, and the stock market doesn't like trouble. Then you have to have the courage and convictions and buy enough of the stock so that it would make a difference to you.

Schloss screens for companies ideally trading at discounts to book, with no or low debt, and managements that own enough stock to make them want to do the right thing to shareholders. If he likes what he sees, he buys a little and calls the company for financial statements and proxies. He reads these documents, paying special attention to footnotes. One question he tries to answer from the numbers: Is management honest and not too greedy? That matters to him more than smarts. When management is very smart but greedy it can spell trouble for investors.

He doesn't profess to understand a company's operations intimately and almost never talks to management. He doesn't think much about timing (am I buying at the low? selling at the high?) or momentum. He doesn't waste time thinking about the economy.

He owns a 1934 edition of Graham's Security Analysis he still thumbs through. It's binding is held together by three strips of Scotch tape.“…Graham was concerned with limiting his risk and he didn’t want to lose money. People don’t remember what happened before and how things were. And that’s one of the mistakes people make in investing as well.”

Schloss first met Warren Buffett at the annual meeting of wholesaler Marshall Wells. The future billionaire was drawn there for the reason Schloss had come: The stock was trading at a discount to net working capital (cash, inventory and receivables minus current liabilities). That number was a favorite measure of value at Graham. Buffett came to work for Graham after the Marshall Wells meeting, sharing an office with Schloss in New York. He left the Graham firm in 1955 and with $100,000 from a few investors began buying "working capital stocks". Success drew in investors, eventually rising to almost a 100. He never marketed his fund or opened a second one. He kept money he had to invest to a manageable size by handing his investors all realized gains at year-end, unless they told him to reinvest. His relative small size helped him to have consistent market beating results and allowed him to select from a wider amount of companies.

About Warren Buffett Schloss mentioned,“He understands businesses – I don’t. We’re buying in a way that we don’t have to be too smart about the business….” His average turnover is 25% implying a holding period of four years, exceedingly lower than the average mutual fund. He averages down in his investment positions as the prices fall and when he feels the investment thesis is still valid.

He recommended being honest when running a partnership, that helps investment managers to do well. He mentioned that in his partnership he never disclosed his holdings and only provided investors with quarterly statements, an audit, and a letter to partners.“We work hard to find our stocks. We don’t want to just give them away. It’s not fair to our partners.” He ran his partnership with almost no expenses. His office was often referred to as a “closet” by Warren Buffett in the 1976 letter. He shared a single phone with his son and paid a small office rent.

Depicting Warren Buffett’s discipline in purchasing securities Schloss told an excellent story of Buffett’s purchase of shares in ABC. Warren Buffett was offered shares at 29, and he refused but countered with an offer of 28. The seller declined, and called back next day to offer the shares at 28. Buffett declined again, and offered 27. They declined his offer of 27 but called later and offered 27 and Buffett countered with an offer of 26, which they took.

Investors should use a philosophy that they are comfortable with to sleep well at night. Investors must be disciplined in following whatever philosophy they choose. That is why, once a sound investment philosophy is chosen, the investor who sticks to it and crystallizes it more and more through the years has eventually good results. Investors have to have self-confidence to stick with their ideas through bad market times.

Schloss liked to have the background on companies in which he was investing.“You’ve got to get a feel of a company – their history, background, ownership, what it’s done, the business they’re in, dividend payments, where earnings are headed. You’ve just got to get a general feel of a company.” Although he said,“you never know all about a stock until you own it.”. He relies exclusively on public information, and avoids meeting with management unless they are nearby. Walter’s son Edwin said,“You can waste a whole lot of energy running all over the country checking on managements of the companies you own. We only go to annual meetings if they’re within a 20-block radius of the office.” He also looked for management that owned a decent amount of stock as an insurance.

He applied his knowledge by inverting it, in the extremely overvalued zone, during the internet bubble he shorted Yahoo (YHOO) and Amazon (AMZN) before the markets tanked in 2000. After that, unable to find cheap stocks, he and Edwin liquidated, handing back investors $130 million. Then Schloss closed his fund with glory: up 28% and 12% in 2000 and 2001 versus the tanking S&P's -9% and -12%.

Just before the housing crisis Schloss flipped through Value Line and stopped finding a furniture company battered by a lousy housing market: Bassett Furniture. The chair and table maker was trading at a 40% discount to book and had a 7% dividend yield. Schloss said something about how book value hasn't risen for years and how the dividend may be under threat. His recommendation was to consider buying when and if the company cuts its dividend. Then it would be even cheaper and it eventually most probably will recover (sounds like it would have been wise to wait for General electric to cut its dividend before buying it not too long ago)! The company indeed cut it’s dividend after that from 20 cents to 10 cents and then to 0 by the end of 2008. By the beginning of 2009 the stock was trading under 1 dollar. His call was right: It now recovered to 8 dollars.

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Walter Schloss never changed his investing philosophy, he refined it, he looked forward to buy decent companies with temporary problems, small or no debt, and selling under book value. After 17 recessions I guess he acquired a good intuition. And he does really pick up unknown, small cap companies as Buffett said. He simply does not want to lose money on an investment and spoke of Benjamin Graham’s essential ability to remove emotions completely from investing. Mr. Market is emotional. But Mr. Graham did not care, he purchased securities strictly on a quantitative basis. Schloss remained close to fully invested throughout his career. It looks like he trusted more the power of companies to preserve value than holding cash, gold, or meager bank deposits who tend to lose due to inflation. He once said,“I think I sleep better owning stocks than owning cash!”. Companies were his favorite currency.

About the author:

Jose Vasquez
I was born in Spain and lived in France, Chile, USA and Belgium. I used to work in IT and Banking. I am a family man, I have a lovely wife, 3 sons and one step daughter. I have humble tastes, I like to stay home and read about companies. I started investing before the internet bubble. I knew little and liked technical analysis so my results were bad. Fortunately I did not have much to lose. Some years later in 2006, bored of doing real state investments, I opened an interactive brokers account and restarted. This time, not wanting to make mistakes, I decided to follow a model: Warren Buffett, he was at good making money via stocks. So I started reading about him, his shareholders letters, the books that he recommended, etc... I started applying his principles, reading 10K's digesting all sources of information. I started buying good and cheap companies to hold forever unless something changed fundamentally. When the housing crisis started I was 75% cash. By then I had identified good companies at very cheap prices so I invested most of my savings in stocks. It doubled fast. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. I changed lifestyle and moved from Belgium to the beach, Brazil, north east coast (www.kuchita.com). The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return, to move away from the inhuman life of civilization and to have some peace and sunny weather. Now I can think and study about companies 60 hours/week. I can finally do what I want full time and can say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! My portfolio is disclosed here: http://www.kuchita.com/view/sumo.php For more:

Visit Jose Vasquez's Website


Rating: 4.7/5 (101 votes)

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Comments

warner13
Warner13 - 3 years ago
Good article. Thanks for posting it
Jose Vasquez
Jose Vasquez - 3 years ago
Thanks for your appreciation warner13, Schloss is indeed an admirable person, I must admit that I have almost never bought a company under book fitting his criteria, but I have seen some very interesting companies in Japan that are in that situation, I just do not feel comfortable enough because it is hard to find enough info about them and I tend to want to know a lot about the company before investing, but I have been thinking about buying several, as a package, mainly based on their financial statements, and in order to diversify the risk.
davidchulak
Davidchulak premium member - 3 years ago
First, that was a great post. You articulated exactly my feelings when it comes to following his methodology. I've not tried it, nor do I feel comfortable....but someday....Thanks.
Jose Vasquez
Jose Vasquez - 2 years ago
“Basically we like to buy stocks which we feel are undervalued, and then we have to have the guts to buy more when they go down,” Schloss said at a 1998 conference sponsored by Grant’s Interest Rate Observer. “And that’s really the history of Ben Graham.”

Edwin Schloss said he figured his father’s investing philosophy and longevity were related: “A lot of money managers today worry about quarterly comparisons in earnings. They’re up biting their fingernails until 5 in the morning. My dad never worried about quarterly comparisons. He slept well.”

Walter Schloss died yesterday.

Rest in peace !

Juan
Cornelius Chan
Cornelius Chan - 2 years ago
Thank you very much for locating the info and posting such an article. I had never heard of Walter Schloss before now. It seems buy and hold does indeed work using the strategies he used. A thousand stocks is a heck of a lot of positions to hold. His investment returns speaks for itself, "success requires no explanation..." Did he never go on holiday or enjoy his money?

My mentor told me it takes 1/3rd skill to buy stocks and it takes 2/3rd's skill to sell stocks and book profit. Perhaps that is why Walter only has 1 tip for selling -- see the 9th factor -- out of 16 factors of value investing.

May he rest in peace.

CWR

augustabound
Augustabound - 2 years ago
I looked at Bassett after reading this article, Walter Schloss made it look so easy. :)

Has he ever spoken to the Amazon and Yahoo! shorts? I know it's a part of the stock list he sent to WEB, but is it simply a matter of little in tangible assets and maybe more obvious, a sky high P/E?

Great article Juan.
Jose Vasquez
Jose Vasquez - 2 years ago
Hi Augustaound, thanks!

He made money shorting stocks during the internet bubble, specially yahoo, I think it represented exactly the opposite of what he looked for: famous company with sky-high p/e and multiple times book value. I guess that from decades of experience it was bound for a correction and he bet on that.

Cheers!

Juan
augustabound
Augustabound - 2 years ago
I was a bit surprised to see in his memo to WEB about his holdings that he shorted 3 stocks but like the ultimate value investor, he saw a fat pitch and swung. Based on the timeline and his track record, I'm sure he did very well with those few shorts.

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