This week Martin J. Whitman, one of the most revered investors in value circles, passed away. He left behind a legacy in the form of Third Avenue Management (Trades, Portfolio), a value-focused investment manager.
Whitman founded the predecessor to the Third Avenue Funds in 1986 and managed the flagship Third Avenue Value Fund since its inception in 1990 up until he stepped down as chief investment officer in January 2012.
Presiding over the Third Avenue Value Fund, Whitman generated outstanding returns for his investors for many decades. From inception to the end of October 2007, the fund returned 16.83% per annum, compared to a gain of 12.33% for the S&P 500. Unfortunately, its performance deteriorated following the financial crisis, and returns dropped to 8.8% per annum until he stepped down in 2012.
When Whitman stepped down, the Third Avenue Value Fund was in crisis. He favored a value-focused, concentrated approach, which had led him into Hong Kong real estate and holding companies. Around 68% of assets were in Asian stocks. This might have made sense for the seasoned value investor, who prioritized assets over everything else, but it was too high risk for the new managers. Following his departure, the fund diversified away from Asia and Hong Kong.
Still, considering his long-term results, Whitman should not be overlooked as one of the most significant value investors of all time. It is interesting to look back at one of his more recent interviews with the Graham & Doddsville publication in the fall of 2011.
We start with a brief description of what the analysts at Third Avenue were looking for in each investment opportunity before they committed capital. The answer: a wide margin of safety:
"We look at hurdle rates in most of our common stock investments. We want to get in at a substantial discount to readily ascertainable net asset value. We want at least a 25% discount. We don‘t go into these types of situations unless we think there are very good prospects that, over the next 3-7 years, the company can increase its net asset value by no less than 10% per annum compounded. We are more conscious of growth in readily ascertainable net asset value than we are in earnings per share. This is unlike Graham and Dodd who said value is created by operations. I don‘t think that‘s real in today‘s world, in the 21st century."
It is interesting here that Whitman criticizes the way Benjamin Graham and David Dodd went about valuing companies. Rather than earnings power, Whitman is focused on asset growth, as he believes that this is the most important financial aspect of a company and gives the most insight into its financial position.
"I have criticized how people use GAAP, including Graham and Dodd, who thought it was so important to find true earnings. GAAP is essential, but it misleads you as an analyst in some respects. Cash accounting, which is not GAAP, also misleads because it doesn‘t give you any measure of wealth creation. GAAP misleads because it focuses on wealth creation and buries cash accounting. It is rules-based, not principles-based. However, GAAP is critical in the USA because it is the only objective benchmark you have. Our portfolio has a lot of financials, income-producing real estate, and a lot of private equity. With these investments, IFRS tends to be more useful than GAAP. Under IFRS, income-producing real estate assets are carried at appraised value."
Whitman was also a vocal critic of GAAP accounting rules and preferred to focus on assets (as noted above) rather than earnings because there is less scope for manipulation.
Disclosure: The author owns no stock mentioned.