Weāve seen how small investors can beat the professionals on Wall Street by not playing by the same rules.
Walter Schloss was such a man.
Well he was a professional but not in the normal sense.
He didnāt play by Wall Street rules. He took the unorthodox route of ignoring news, ignoring tips, sticking to cigar butts and holding thousands of stocks over his lifetime.
The result?
Annualized Return of 15.6%
Hereās a table view. Unfortunately, data is only available up to Q1 of 1984.
Schloss Partnership Annual Returns 1956 to 1984 Q1
Over this period of 28Ā¼ years, the Schloss partnership returned a staggering 21% CAGR.
Just to show you how good he was, hereās a side by side of Walter Schlossā performance against Buffett and the Standard & Poor's over their overlapping periods.
Whatās impressive about both Schloss and Warren Buffett is their ability to have a good year even in a down year for the market.
(You can also see why Buffett is a legend. His performance speaks for itself. Sure there are lots of ups and downs but even his ādownā years are positive.)
Look at the chart. It proves that you can do well independent of the market.
Now whatās most impressive about Walter Schlossā record is that he didnāt have a college degree.
So how did he do it?
Well letās get into his brain and find out based on the many quotes Iāve scoured from the internet.
The Schloss investing approach ā Quick summary
Philosophy and style
Investors are best served using a Benjamin Graham value approach, looking for stocks that are hitting new lows and those trading at a price lower than their book value per share.
Universe of stocks
Stocks are selected from among well-known āCampbell Soupā companies. Exclude international stocks and those in industries with which the investor is unfamiliar.
Criteria for initial consideration
- Ten-year track record
- No long-term debt
- A low price-to-book-value ratio
- A stock at or near its 52-week low price
- High insider ownership
Portfolio construction
- Limit holding of one stock to no more than 20% of entire portfolio
- Well-diversified portfolio of up to 100 stocks
- Holdings weighted based on their perceived values, putting less money in positions the investor is less sure about
- Use limit orders to purchase stocks
Stock monitoring and when to sell
In general, try for a 50% profit from any holding before selling. If a stockās price is falling and the companyās fundamentals are sound, buy more.
The Schloss Approach in Brief | Source: AAII
Walter Schloss on his investment philosophy
Keep things clear and simple. Thereās no need to chase complicated stocks or situations if you donāt understand it.
"When it comes to investing, my suggestion is to first understand your strengths and weaknesses, and then devise a simple strategy so that you can sleep at night.
"I donāt like stress and prefer to avoid it, I never focus too much on market news and economic data. They always worry investors.
"You have to invest the way thatās comfortable for you.
"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.
"I think investing is an art, and we tried to be as logical and unemotional as possible. Because we understood that investors are usually affected by the market, we could take advantage of the market by being rational. As [Benjamin] Graham said, āThe market is there to serve you, not to guide you!ā
"I like Benās analogy that one should buy stocks the way you buy groceries not the way you buy perfume
"The ability to think clearly in the investment field without the emotions that are attached to it is not an easy undertaking. Fear and greed tend to affect oneās judgment."
He goes on about the way he approaches building a portfolio and protecting his capital.
"Donāt buy on tips or for a quick move. Let the professionals do that, if they can.
"Remember that a share of stock represents a part of a business and is not just a piece of paper.
"Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
"Listen to suggestion from people you respect. This doesnāt mean you have to accept them. Remember itās 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.
"Most look at earnings and earnings potential; well I canāt get into that game.
"I used the same investment approach I used at Graham-Newman finding net-net stocks. It was all about capital preservation because I had to serve in the best interests of my investors. Many of them were not wealthy, and they needed me to generate returns that would allow them to cover their living expenses.
"I try to protect myself from permanent loss of capital by investing in stocks that are depressed.
"When you buy a depressed company itās not going to go up right after you buy it, believe me.
"I like to buy companies with very little debt so it has a margin of safety.
"I like to buy basic businesses not high flyers that sell at huge multiples.
"Iām not very good at judging people. So I found that it was much better to look at the figures rather than people.
"We donāt own stocks that weād never sell. I guess we are a kind of store that buys goods for inventory (stocks) and weād like to sell them at a profit within four years if possible.
"Remember the word compounding. For example, if you can make 12% a year and reinvest the money, 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.
"You never really know a stock until you own it."
Walter Schloss on buying stocks
Walter Schloss ran with the idea of buying cheap stocks and taking a more quantitative approach. Instead of following every stock he owned, he heavily focused on valuation and buying at a discount to his intrinsic value.
You donāt have to perform complex valuations either.
At old school value, Iāve provided guides of simple stuff like a net-net balance sheet calculation as well as more complicated Earnings Power Value models which you can see from the list of best stock valuation methods.
The key however, is to know how to value stocks. Iāve even put together an ebook on all the valuation methods that I use in detail.
Donāt take my word for it though. Listen to what Schloss has to say.
"If a stock is cheap, I start buying.
"Somehow I find it difficult to buy a stock that has gone up.
"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.
"Basically, we try to buy value expressed in the differential between its price and what we think its worth.
"Use book value as a starting point to try and establish the value of the enterprise.
"Price is the most important factor to use in relation to value.
"We basically followed the idea of buying companies selling below working-capital ā at two thirds of working-capital.
"Be sure that debt does not exceed 100% of the equity.
"[On net-net stocks becoming almost impossible to find] We changed our strategy a little, but remained true to Grahamās principle of downside protection. We looked for stocks that were selling below their book value. What we tried to do was to buy assets at a discount instead of buying earnings. Earnings can change quickly, but assets donāt, and so the new strategy worked well for a while.
"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 is attractive. Three years before the stock sold at 20 which shows that there is some vulnerability in it.
"When I buy a stock that is depressed it hardly ever turns around immediately.
"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.
"When I buy a stock, I never visit or talk to management because I think that a companyās financial figures are good enough to tell the story. Besides, management always says something good about the company, which may affect my judgment. I know a lot of good investors who like to talk to management and visit companies, but thatās not me. I donāt like that kind of stress, and if I had had to run around visiting so many companies, I would have been dead after a few years!
"We donāt put the same amount of money in each stock."
Walter Schloss on selling stocks
Schloss subscribed to the idea of selling at what he believed to be intrinsic value and didnāt focus so much on what the stock did two to three years later.
Donāt we all get in the habit of looking at past stocks, and if is 2x after you sold, you kick yourself and say you should have kept it?
Schloss is no different but he moves on and focuses on the next stock.
"[On purchasing a cement company called Southdown] I bought a lot of it at $12 or something similar. After two or three years, when it reached about $28, I sold it because it had reached my calculated value, and I didnāt focus too much on its growth opportunities. It reached $70 a while later. I could only be humble and move on to find the next cheap stock.
"But some times you have to take advantage of the opportunity to sell and then say OK, itāll go higher.
"As the saying goes, a stock well bought is half sold. I think Ben was an expert in that area."
Selling stocks is hard. But itās a lot easier when you know what a stock is worth.
When you try to sell a car, you wouldnāt blindly list the car without knowing what itās worth. You would do your research, look up comparables, look at the quality of your car and price it accordingly at fair value.
Nothing different with stocks.
"Each year we buy stocks and they go up; we sell them and then we try to buy something cheaper.
"I never put a stop loss on my holdings because if I like a stock in the first place, I like it more if it goes down.
When I buy a stock, I have kind of an idea where I want to sell it.
Walter Schloss' Library of Links
Iām not the only one who admires Schloss.
To learn more about the legendary Walter Schloss, check out these links.
- Comprehensive guide on Walter Schloss (Valuewalk)
- Barron's Article ā The Right Stuff
- Guide to Walter Schloss Investing (net net hunter)
- GuruFocus article on Schloss (GuruFocus)
- An overview of Walter Schloss and links ( Basehitinvesting)
- Walter Schloss on Ben Graham and Security Analysis PDF (csinvesting)
- Walter Schloss interview with Outstanding Investor Digest PDF
- The Walter Schloss approach to investing PDF (AAII)
- Walter Schloss speech ā65 Years on Wall Streetā PDF
- Dozen things learned from Phil Fisher and Walter Schloss
- Walter Schloss ā Keep it simple and cheap (Hurricane Capital)
