Walter Schloss Revisited
In this article, I tried to summarize his investment philosophy from his writings, although I am still looking for his memoirs, “The Memoirs of Walter J. Schloss: A Personal and Family History.” Not finding it in Amazon, I requested the university library through document delivery and to my surprise, they replied me: “We are sorry, but we have been unable to find a lending location for the following item and must cancel your request. We cannot locate this book at any library. Also, the publisher no longer appears to be in business.”
That's a book with 96 pages published in 2003 by September Press (I would be immensely benefited if someone has this text or any clue about the whereabouts of this text). Probably it’s going to be another Seth Klarman’s “Margin of Safety.” I will mostly rely on his writings and lectures here.
I consider myself lucky since I got the lecture that Walter gave in a 1993 Columbia Business School upper level seminar in value investing where he talked quite a bit about himself, his interest in Wall Street, his early career as a stock runner at Loeb Rhoades and how he ended up with Ben Graham.
“Wall Street sounded interesting and exciting but I instinctively didn’t like the gambling part."
“It was a great experience and I remember taking two different classes with him. The firm paid for the class which I think was $10 a semester but perhaps it was $20.”
So it was Benjamin Graham,who ignited the real sense of investing in Walter Schloss:
“Ben didn’t want to lose money. He had had a rough time during the Depression and in 1938 to 1940 when I tool his courses, he was looking for protection on the downside.”
Since he liked the way Ben thought, he stuck around with the idea of not losing money throughout his career as a money manager. When investors get scared when stock prices go down, Walter's thoughts were the other way around:
“I never have put in a stop loss order because if you like a stock and buy it and it goes down, then you should buy more if you can afford to. I find it very difficult to buy a stock that has gone up after we start buying it.”
Regarding the holding period, unlike Buffett, Walter had a holding period of four years:
“In any case I find that we don’t own stocks that we’d never sell. I guess we are kind of a store that buys goods for inventory (stocks) and we’d like to sell them at a profit within 4 years if possible.”
When asked, what kind of stocks does he look at for investments, Walter replied: "We look for stocks that are depressed."
Then he tried to answer the following questions:
Why are they depressed?
Are they selling below book value?
Is goodwill in book value?
What has been the high low over the past 10 years?
Do they have any cash flow?
Do they have any net income?
How have they done over the past 10 years?
What is their debt level?
What are their profit margins?
How are their competitors doing?
Is this company doing poorly compared to its competitors?
What appears to be the risk on the downside vs. the upside potential?
How much stock do the insiders own?
Based on the above factors and perhaps a few other items, if the figures looked satisfactory, Walter used to take an initial position (5% but could go up to 10-12%). Then he watched the action of the stock and decided how much more he might want. It depended a good deal on price.
It would be redundant to mention here his remarkable performance or the testimonials (since so much have been written on him after his death, at least in guru focus).
I understand the 16 factors that Walter identified for making money in the stock market in a 1994 Walter & Edwin Schloss Associates LP documents (see my article "Have Patience. Stocks Don’t Go Up Immediately": Walter Schloss (1916-2012) comprise his investment philosophy.
I rather draw your attention to another Schloss 1996 lecture “Why We Invest the Way We Do” at the Behavioral Economics Forum at the Harvard Faculty Club in Cambridge, Mass., where he talked quite a bit about his investment philosophy. “I don’t think investing is a science. I rather look at it as part art and part science with some boundaries. My son, Edwin, and I don’t consider our approach a behavioral science, it’s just a bargain hunting …"
So that’s margin of safety, the secret sauce of investment success introduced by his guru Ben Graham, and he followed this simple but difficult-to-embrace concept throughout his life.
However, unlike some of the legendary value investors, Walter Schloss was in favor of wide diversification.
“We buy a lot of securities. We know a lot of people who don’t like our kind of diversification, but we can’t help that.”
At a seminar at the Harvard Faculty Club, Walter mentioned, “I also liked the idea of owning a number of stocks. Warren Buffett is happy with owning a few stocks and he is right if he’s Warren but you aren’t, you have to do it the way that’s comfortable for you and I like to sleep nights.”
Warren has talked a bit about this in his super article, “The Superinvestors of Graham-and-Doddsville.”
“Walter has diversified enormously, owning well over 100 stocks currently. He knows how to identify securities that sell at considerably less than their value … … He owns many more stocks than I do …"
When I talk about diversification with my students, I mention diversification only makes sense when you know where you are diversifying. Think about this: If you are putting your eggs in different baskets (for the sake of diversification) and if you are not quite sure about the snakes in some of these baskets, you are not going to make money (even if you include negatively correlated stocks in your portfolio).
Walter Schloss was a contrarian, even for managing stress.
“We have found that if we are somewhat contrarian, we seem to do better than if we purchased companies that are doing well today. When we buy depressed stocks, we seem to reduce our stress. Some people seem to thrive on stress, but we feel in the long run it is bad for them.”
Probably that’s why Peter Lynch had to close his shop after 10 years, whereas Walter's was open for more than 40 years.
While some successful investors (Peter Lynch or Stephen Jarislowsky) relied on discussions with the management, Walter thought that was little help, particularly when investing in a distressed company.
“When we buy into a company that has problems, we find it difficult talking to management as they tend to be optimistic. Very rarely will an officer say ‘We are doing badly, the outlook is poor and we are very pessimistic about our future’ …”
It seems like Walter hated to be second in the line when it came to liquidation or bankruptcy (there were chances of bankruptcy since he was investing in distressed companies). “We don’t like a lot of debt and we don’t think most value investors care for it either.”
Regarding the circle of competence, a term coined by Warren Buffett, Walter’s thoughts are:
“We try to do what is comfortable for us so that we don’t develop ulcers. It is important to know what you like and what you are good at and not worry that someone else can do better.”
And I think the following statement reasonably depicts Walter Schloss’ investment philosophy that today’s investors can reliably bank on:
“If you are honest, hardworking, reasonably intelligent and have good some sense, you can do well in the investment field as long as you are not greedy and don’t get too emotional when things go against you.”
That reminds me of the title of my last article, the fourth point of Walter Schloss, “Have patience. Stocks don’t go up immediately.” Walter has wrapped up his lectures, pointing toward a discipline of knowledge where we have serious interests, behavioral finance, because we do believe that we are homo sapiens (made of flesh and blood, so we have emotions and cognitive biases) as opposed to homo economicus (rational beings).
RIP Walter Schloss.
Mohammad Siddiquee is a Ph.D. finance candidate at the University of New Brunswick, Fredericton, Canada. He is an avid value investor and runs a value investing research website at www.patienceinvesting.com