I’m exceptionally proud and honored to present an interview with one of the top value investors of India, Mr. Chetan Parikh. This interview with Mr. Parikh represents one of the highlights of my career. Mr. Parikh is a man whom I admire and who has extensively contributed to the value investing community (via Capital Ideas Online and his numerous writings). I hope you enjoy the interview.
Mr. Chetan Parikh’s Background
Chetan Parikh is a Director of Jeetay Investments Private Limited, an asset management firm registered with SEBI. He holds an MBA in Finance from the Wharton School of Business and a BSc in Statistics & Economics from the University of Bombay. He has been investing in the Indian capital markets through proprietary investment companies and family trusts.
Chetan was rated amongst India’s best investors by Business India magazine. He is also the co-promoter of capitalideasonline.com, a well regarded investment website. His writings have been published in Business Standard, Business World, The Economic Times, and Business India. He is a visiting faculty member at Jamnalal Bajaj Institute of Management Studies (University of Bombay) for the MBA course.
Q. There are many different approaches to investing. What led you to choose the value approach?
A. Value investing is a logical, safe and disciplined approach to investing. It requires a lot of patience which fits in with my temperament.
Q. Which investors do you admire? Besides these investors who else has influenced you?
A. Any value investor can learn a lot from the Masters. In India I’ve listened to and learnt from Prof. Rusi Jal Taraporevala and Mr. Chandrakant Sampat.
Q. What’s your opinion of the efficient markets hypothesis and practitioners of technical analysis?
A. I believe that the efficient market hypothesis in the various avatars (strong, semi-strong and weak) is not correct. Sometimes prices deviate far away from intrinsic values and it is possible to earn high risk adjusted returns. In fact, the lower the downside risk, the higher can be the upside reward. I do not know anything about technical analysis.
Q. Tell us about your approach to fundamental analysis-what is your focus? How do you search for your investment ideas? Where do most of these ideas come from? Describe your evaluation process (both quantitative & qualitative)? How long do you hold on to your positions?
A. My firm, Jeetay, principally invests in publicly traded Indian securities and seeks to maximize investors’ capital by buying securities trading at values materially lower than their true business value.
Jeetay aims to achieve high absolute rates of return while minimizing risk of capital loss. Jeetay combines the analytical vigor of determining the fair value of a security with a deep understanding of the Indian markets. Jeetay will invest in securities where it can ascertain the reasons for the market’s mispricing and the likelihood of the mispricing being corrected.
Jeetay follows the value investment philosophy, which means that the objective is to buy a security trading at a significant discount to its intrinsic value. Since the focus is on discovering undervalued stocks, the fund doesn’t base its investments on macro-economic factors like GDP growth.
Jeetay determines intrinsic value as the present value of the future cash flows of a company discounted at a rate that properly reflects the time value of the money and the risks associated with the cash flows. In other cases Jeetay invests in “Special Situations” which involve the following:
Repositioning assets to higher uses
Mergers and acquisitions / open offers
Restructuring troubled companies
The fund invests in a company if the market price is quoting at a discount of at least 60% to the intrinsic value. It sells when the market value approaches intrinsic value or it finds a security trading at a steeper discount to intrinsic value.
Jeetay believes that while in the long term, a company is valued by its fundamentals, short term mispricing occurs due to investor psychology, liquidity and macroeconomic factors. This provides opportunities for the diligent and patient investor to make outstanding risk-adjusted returns.
The time horizon of Jeetay is 3-5 years. It believes that short-term market movements can be volatile and the market may recognize mispricing only in the medium to long term. Hence the emphasis is on understanding the corporate strategy and the resultant cash flows for a 3-5 year period. The probability of the markets recognizing the mispricing becomes high over the medium to long-term period.
The firm does not limit its investments to certain asset classes or sectors. The fund evaluates any sector or asset class where a conservative estimate of intrinsic value is determinable with a reasonably high probability and invests if the security is available at a reasonable margin of safety.
The firm does extensive research to arrive at estimates of expected cash flows, asset values and earnings. Jeetay culls information from public databases, quarterly and annual filings, annual reports, meetings with management, competitors, vendors, customers and other industry participants, industry experts, trade journals and bankers. Jeetay has extensive networks in India to get data and information for superior analysis. Jeetay believes that a disciplined private equity approach to investing that stresses on buying at a discount to intrinsic value will deliver consistent absolute above average investment returns and safeguard capital irrespective of the state of the markets.
Jeetay believes that the following steps are essential to its process:
1. Opportunity Identification. Jeetay identifies opportunities through a multitude of ways. Jeetay has numerous financial models and screens that are used to filter investment opportunities within the framework of the investment philosophy. Jeetay has many contacts and professional relationships. This gives it many opportunities consistent with the investment philosophy.
2. Analysis. Jeetay does intensive financial and qualitative analysis on companies once an opportunity is identified. The analysis is mainly to arrive at whether a disparity exists or not between the traded value of the security and its intrinsic value. Jeetay has substantial experience in determining the intrinsic value of a company across sectors. Multiple valuation metrics including discounted cash flow analysis, price to earnings, dividend discount model, price to sales, price to book, comparative analysis is used to arrive at the valuation of a company.
Other than financial analysis, Jeetay extensively meets every possible associate of the company to understand the opportunity better. These include vendors, customers, middle management, bankers, competitors, large stakeholders and senior management. This helps Jeetay arrive at a closer intrinsic value and also exit an investment if unfavourable events arise or the team’s original calculation of intrinsic value was wrong.
The analysis would focus on the 3B’s, – Understanding the business, analyzing the balance sheet and looking for bargains.
Take each in turn:
Business: What is the nature of the business and its competitive strengths and weaknesses? What is the competitive ecological niche that it occupies and how protected are its profits from predators there? What are the nature of the entry barriers or ‘moats’ - intangible assets, switching costs, network effects, cost advantages? How wide and deep are the moats? Does the business cover its cost of capital? A qualitative assessment of the business should be made to understand whether it is a superior or inferior business. Evidence of pricing power or the ability to lower cost of production and distribution should be searched for.
Balance Sheet: In order of importance is the balance sheet, the cash flow statement and the profit and loss account.
Bargains: One need not to be able to determine value exactly to know whether a stock is cheap or not. As Ben Graham wrote, “To use a homely smile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age, or that a man is heavier than he should be without knowing his weight.” A discount to value, a ‘margin of safety’ is paramount, without which an investor is relying on the whims of “Mr. Market” for his investment return.
Q. As a follow up question, how do you determine intrinsic value?
A. The textbook definition of Intrinsic Value is the present value of the future cash flows discounted at a rate that realistically reflects the time value of money, risk and volatility of the cash flows.
The problem is that it is difficult to:
1. determine the future free cash flows
2. determine the discount rate
3. determine the terminal value
There are very few companies, i.e. those that are franchises earning well over their cost of capital and growing whose intrinsic value can be calculated using the Dcf approach. Ben Graham’s method of bargain identification is useful in other cases.
You don’t have to calculate intrinsic value with precision (especially where it is not possible) to know whether a stock is cheap in seldom to its value or not.
Q. Do you invest in foreign companies? If so, do you evaluate foreign companies different than those based in India and how do you hedge currency exposure(s)?
A. I have not invested in foreign companies as of yet. Sitting in India, I would have to invest in the large cap stocks in foreign markets, and have not as yet found large caps in USA to be cheap in relation to my investing universe in India. Whilst markets may change, valuation principles are universal-they are the same whether it’s the USA or India.
Q. How many stocks do you typically hold in your portfolio?
A. In my family portfolio, given the time horizon and tax considerations, there is a heavy concentration on a few stocks that have franchise value and entry barriers. There are smaller positions, but the bulk of the portfolio is in a handful of stocks.
In the managed accounts, price in relation to value is of paramount importance and many of the businesses are clearly not franchises. The portfolio thus in the managed accounts tends to be more diversified with roughly around 18-25 positions. Cash is carried at all times in the managed portfolios, the level directly correlated with the valuation of the broad market.
Q. Do you invest in any fixed income? If so, tell us about the role of fixed income investments in your portfolio.
A. I do not normally invest in fixed income securities. Cash is usually a default position and varies directly with the level of the market. The cash is usually kept in the bank or in money market funds. I do not like to take a credit risk with money that I know will eventually be opportunistically deployed in the stock markets. The key is to be able to sit on your low-yielding cash without losing your patience.
Q. . How do you judge a company’s management?
A. There are three ways of looking at management:
1. their integrity
2. their competence – both operational and in capital allocation
3. their corporate governance
In the end you want to deal with people who do not make your stomach churn. Integrity and competence are both necessary in top management. Finally there is the factor of the passion to improve the game by never becoming complacent.
Sometimes a good price can cover a multitude of sins, including poor management. But if I had to hold a non-franchise investment for any length of time, management would certainly be an important factor. In many cases, it is the jockey, not the horse that one should bet on.
Q. What makes you sell an investment?
A. I sell when:
My original thesis was wrong
Price is reached
A better option comes along
Ben Graham’s criteria should be kept in mind. Switch for:
1. Increased security
2. Larger yield
3. Greater chance for profit
4. Better marketability
Q. How do you look at risk?
A. Risk is very subjective. Academic theory has one definition of risk namely standard deviation which is wrong. Actually, if one had to use statistical distributions to measure risk, then there are three dimensions, Variance, Skewness & Kurtosis.
I do not think however that risk can only be captured by statistical measures. To me, risk is simply the chance of permanent loss of capital and an investors’ job is to eliminate that risk. He may not be able to do so for individual securities, even with a margin of safety, but he has to do it in a portfolio context.
Q. What’s your take on leverage?
A. Leverage is one of the two things that can cause a permanent loss of capital to a value investor. Avoid it, unless you are willing to take a risk of a permanent loss to your capital. The other thing that can cause a permanent loss of capital is holding on to overvalued stocks, but I assume that a value investor would not do that.
I always carry cash for optionality, rather than borrow against my holdings should the opportunity arise.
Q. Do you invest in commodities, gold, real estate, etc? If so what has been your experience with these classes?
A. I have legacy investments in real estate. I view it as an inflation hedge and a different asset class in the portfolio.
Currently I have investments in gold as a hedge against a highly likely decline in the value of the dollar and a meltdown in financial assets. The economic problems in US are severe and the wrong treatment is being given. When fiscal and monetary insanity prevails, gold always reigns supreme. I’m not making a directional bet on gold prices – it is only a hedge against my financial investments.
Q. Tell us a little more about your involvement with special situations?
A. It depends on the definition of “special situations”. If special situations means a value stock with identifiable catalysts like change in management, operational and financing restructuring, buybacks, mergers and acquisitions etc, then we certainly do invest in special situations. We have investments in spin offs and in open offers as a result of takeovers.
Q. Have you ever taken the role as an activist investor, would you ever do so?
A. I’ve never wanted to take a confrontational attitude with management although sometimes I’m forced to. If I’m not happy with their policies, I sell - but my aim is to influence management through logic and rationality, not through financial blackmail.
There is a grey area however. I’ve been connected with the press through my columns in various newspapers and magazines and I’ve written about instances of corporate misgovernance there. But I’ve never threatened management.
I do not have the temperament to fight management or for that matter, anybody. I believe in exiting relationships where there is no mutual respect, rather than slugging it out for dominance.
Q. We understand that you are very focused on bottom up value investing-what has the financial crisis taught you?
A. I wrote this piece awhile ago and it would be related to the question above.
It may be interesting to use a cross-disciplinary approach to the problems and mistakes made by banks in the sub-prime market.
The power of rewards that leads to repeated actions and the flawed compensation structure that led to misaligned incentives could be one mental model. As Raghuram Rajan pointed out in Financial Times (Jan 9, 2008), the compensation practices in the financial sector are deeply flawed. The compensation is based on the so-called ‘alpha’ that a manager of financial asset generates. There are three sources of ‘alpha’:
1) Truly special abilities in identifying undervalued assets (eg. Warren Buffett)
2) Activism – using financial resources to create, or obtain control over, real assets and to use the control to change the payout obtained on the financial investment.
3) Financial engineering – financial innovation or creating securities that appeal to particular investors.
Many managers create ‘fake alpha’ i.e. they appear to create excess returns but are taking on ‘tail’ risks which produce a steady return most of the time as compensation for the very rare, very negative returns (‘black swans’). The AAA rated CDOs generated higher returns than similar AAA rated bonds. The ‘tail risk’, so evident in hindsight, of the CDO defaulting was not as small as perceived and so the excess return was compensation for that.
The credit rating agencies that rated these securities as AAA because of their ‘insured’ status were themselves wrongly incentivized (compensated by the issuers of the securities). Furthermore once their peers started issuing AAA ratings, ‘social proof’ came into play and the ratings war as to who assigned the highest ratings for junk became a classic Prisoners’ Dilemma..
This is proving to be a game of chicken between the regulators and the players (banks and monoline insurers). In a classic game of chicken, two cars drive towards each other. The first driver who turns loses. Of course, if neither car swerves then there is a crash. The best outcome for each player results when he goes straight whilst his opponent turns. Insane players have a massive edge in a game of chicken. At this point of time, the jury is out given the level of insanity in the system.
Q. How have you evolved as an investor?
A. I guess the process of evolution is never over. I started out knowing nothing but efficient markets and so the leap to value investing was a big one. I know I’ll never leap out of value investing, but the nuances may undergo changes, as also my ability to widen and deepen my circle of competence.
Q. What is the most interesting part of your job?
A. It is searching for investment ideas, working out the odds and reading from a wide variety of sources.
Q. Which books would you recommend?
A. Here are a few, but they are by no means exhaustive.
Everything by Jared Diamond
Everything by Garett Hardin
“The Road to Serfdom” - Friedrich Hayek
“The Prophet of Innovation”
“More than your know” - Michael Mauboussin
“The Robot’s Rebellion”
“The mind of the market” - Michael Shermer
Try to read all of Mr. Munger’s book recommendations and also the books in Mr. Peter Bevelin’s Bibliography in “Seeking Wisdom: From Darwin to Munger”. I do not think that I’ll be able to read all the books that have been recommended in my life time but I’m going to give it a shot.
Q. What is the biggest mistake keeping investors from reaching their goals? How have you guarded yourself against this folly?
A. Greed, fear, sloth and envy are the four emotions that are positively inimical to becoming a better investor.
Meditation, detachment from results, but attachment to efforts, yoga, discipline in living and thinking are some of the ways for self-improvement in investing.
One must also have an open mind to new ideas and try to become in the words of Mr. Munger “a learning machine.”
Q. What should investors understand before investing in India?
A. Indian markets are very volatile, so be very careful on entry prices. “Growth” is a seductive term and stories woven about growth even more seductive, but be very careful of paying too much for it. Homework matters. Liquidity can dry up, so be clear whether you can live with relatively illiquid positions.
Q. If you could do anything besides allocating capital what would you do?
A. I would teach and write more often than I do.
Q. What message/advice would you give to readers of SimoleonSense?
A. Read a lot, be disciplined, be humble about your knowledge and stay within your circle of competence.
Q. What does the future hold for you, your funds, and website? Are you going to do this forever?
A. As long as I can, mentally and physically.
Miguel Barbosa: Mr. Parikh thank you for taking the time to interview with us.
Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with management of the highest integrity and ability. Then you own those shares forever. I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.
February 11, 2011
Benjamin Graham and Security Analysis: A Reminiscence
Walter J. Schloss
Ben Graham was an original thinker as well as a clear thinker. He had
high ethical standards and was modest and unassuming. He was one
of a kind. I worked for him for nearly 10 years as a security analyst.
In re-reading the preface to the first edition of Security Analysis, I
am impressed all over again with Ben’s views. I quote . . . “[W]e are
concerned chiefly with concepts, methods, standards, principles, and
above all with logical reasoning. We have stressed theory not for itself
alone but for its value in practice. We have tried to avoid prescribing
standards which are too stringent to follow or technical methods which
are more trouble than they are worth.”
Security Analysis says it all. It is up to analysts and investors to put
Ben’s ideas into practice.
Back in 1935 while working at Loeb Rhodes (then called Carl M.
Loeb & Co.), one of the partners, Armand Erpf, gave a good piece of
advice when I asked him how I could get into the “statistical department.”
In those days and perhaps today to some extent, the best way
to advance was by bringing in business. If you had a wealthy family or
friends, you brought in commissions. Security analysis was in its infancy
and who you knew was much more important than what you
knew. If you didn’t have connections, it was difficult to get ahead. In
any case Mr. Erpf told me that there was a new book called Security
Analysis that had just been written by a man called Ben Graham.
Reproduced by permission from the private writings (1976) of Walter J. Schloss.
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“Read the book and when you know everything in it, you won’t
have to read anything else.”
I took Ben’s course in Advanced Security Analysis at the New York
Stock Exchange Institute (New York Institute of Finance).
Ben was a good speaker, enthusiastic and logical. Ben did something
that I haven’t seen done often. He would take an undervalued situation
at that time, such as the bankrupt bonds of Baldwin Locomotive,
and show how much the new securities would be worth based on their
projected earning power and assets and relate this to the price of the
bonds. Many bright Wall Streeters such as Gus Levy of Goldman Sachs,
who later became the top arbitrageur in the country, used to take his
course. I often wondered how much money people made on Ben’s ideas
by transforming them into investments.
Ben was very generous with his thoughts and his time, particularly
with young people. By offering me a job as his security analyst as I was
about to leave the Army at the end of 1945, he changed my life. I know
he helped others in our field too.
At Ben’s memorial service, Dave Dodd, Ben’s co-author, told how
he had got involved in the book.
It seems that Ben was asked to teach a course at Columbia University
on investments and he agreed to do it with the stipulation that he
would only do so if someone would take notes. Dave Dodd, a young
instructor, volunteered and took copious notes at each of Ben’s lectures.
Ben, using the notes, then went ahead and wrote Security Analysis. As
Dave said, Ben did the work but he insisted that Dave get credit by being
Professor Dodd went on to become a very successful investor and a
director of Graham-Newman Corporation, an investment trust that
Ben had founded in 1936 with his partner, Jerome Newman.
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 one’s judgment. Because Ben was not really very aggressive
about making money, he was less affected by these emotions than
were many others.
Ben had been hurt by the Depression, so he wanted to invest in
things that would protect him on the downside. The best way to do this
was to lay out rules which, if followed, would reduce his chance of loss.
2 BENJAMIN GRAHAM AND SECURITY ANALYSIS
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A good example of this was the day I happened to be in his office at
Graham-Newman when he received a telephone call that they had
bought 50 percent of Government Employees Insurance Co. (now
GEICO). He turned to me and said, “Walter, if this purchase doesn’t
work out, we can always liquidate it and get our money back.”
The fact that GEICO worked out better than his wildest dreams
wasn’t what he was looking for. As the saying goes, a stock well bought
is half sold. I think Ben was an expert in that area.
Graham-Newman followed the precepts set down by Ben and the
fund prospered. Compared to today’s investment company, it was tiny.
Its total net assets on January 31, 1946, were $3,300,000.
Ben’s emphasis was on protecting his expectation of profit with
minimum risk. If one wants to get hold of Moody’s Investment Manuals
for the 1947–1956 period, it is interesting to see Graham-Newman’s
holdings. Many of them were small, practically unknown companies
but they were cheap on the numbers. It is instructive to read their
annual report for the year ended January 1946. It states that their general
investment policies were twofold.
1. To purchase securities at prices less than their intrinsic value as
determined by careful analysis with particular emphasis on the
purchase of securities at less than their liquidating value.
2. To engage in arbitrage and hedging operations.
I helped Ben with the third edition of Security Analysis, published in
1951. In the appendix is an article on special situations that first
appeared in The Analysts Journal in 1946. In the article, he had worked
out an algebraic formula for risk-reward results that could be applied
today, 37 years later.
In 1949, The Intelligent Investor was published. This was a book for
the layman but it focused on security analysis and gave prestige to the
field. Its fourth revised edition is still in print.
One day, I came across a very cheap stock based on its price at the
time, Lukens Steel. We bought some but expected to buy more.
At this point, Ben went out to lunch with a man who kept telling
Ben about one blue chip after another. At the end of the meal he asked
Ben if he liked anything and Ben said we were buying some Lukens Steel.
Benjamin Graham and Security Analysis: A Reminiscence 3
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I doubt if it took a day before the man went out and bought a great deal
of Lukens and pushed the stock out of our buying range. I had the
impression after Ben told me the story that he didn’t want to be rude
and hadn’t realized how important his comments were.
He tried to keep things simple. He wrote that he didn’t believe security
analysts should use more than arithmetic and possibly a little algebra
for any investment decision.
Because Ben was a cultured, many-faceted man, he didn’t spend as
much time on investments as did others in the field. He liked to try
new ideas. In the late 1930s he became involved in promoting his evernormal
granary theory and wrote a book on it called Storage and Stability
in which some commodities and metals would be used as a backing
for our currency. His ideas made sense and with cotton at six cents
a pound and other raw materials at low prices, it was an interesting
proposal. He never had the clout to sell it to the Congress, although
Bernard Baruch, a friend of his, supported the idea and it could have
been a useful way to help the farmers and reduce the threat of inflation.
Of all the things that Ben accomplished in his lifetime, Security Analysis
was, to me, his greatest achievement.
Ben Graham was the leader in giving status to security analysts. It
was a privilege to know him.
February 04, 2011
Walter Schloss’ Presentation at The Benjamin Graham Center for Value Investing
July 25th, 2010 · 1 Comment · Uncategorized
Walter Schloss conducted a recorded video / audio presentation at the Richard Ivey School of Business’ Benjamin Graham Center for Value Investing. If you would like to see the audio / video, we have it on our value investing resource page. In this post, I am going to take notes on Schloss’ speech and add some commentary later in the week. Enjoy.
Started fund in 1955 when Graham said he was going to retire
Schloss was left handed (I never knew that)
Started out with 19 partners, each with approximately $5,000
Stayed in field until 2001 (or 2003…couldn’t recall). Son couldn’t find any good value stocks.
Started work when his father lost his job – the family had no money. Started off making $15/week. Wanted in the research department. Was denied. Was told to read “Security Analysis”
Question: How do you choose stocks? Answer: Stocks that are hitting new lows. Schloss fines Value Line very helpful. He doesn’t have a computer and likes to look at the numbers. He doesn’t talk to management teams.
Went to work for Graham in the beginning of 1946
Question: What process did you follow to minimize mistakes? Answer: I don’t like to lose money and therefore buy stocks that are protected on the downside and then the upside takes care of itself. Look for companies that do not have a lot of debt. By looking at the proxy statement and annual reports, can get a sense of how much stock the directors own, who owns a fair amount of stock, and the history of the company.
Look at companies selling at new lows. It means the company has problems. Debt exacerbates these problems.
Love companies with simple capital structures. Not a lot of debt. The company has to have history. Management needs to own stock.
Schloss admits he was never good at evaluating management character. Therefore he stuck to the numbers.
Value Line is helpful because you get a good sense of history on the company because they have 10-15 years of performance data.
Question: If stock falls, what do you do? Answer: If I like a company, I’ll buy more on the way down. Stock brokers do not like recommending stocks that are going down. The stockbrokers don’t want to look like fools. People get nervous when stocks go lower.
Likes to try to get 50% profit. Only long-term profits (don’t want to pay short term taxes)
Admits that he makes mistakes in sales. He will buy at $30, sell at $50, and see it go to $200
Likes stocks selling below book value. Reiterates how much he hates debt.
Read annual report. Figure out why the company is having problems.
If you get a stock selling significantly below book value, has a good history over 20 years, and little debt with lots of management holdings, probably a good purchase.
Margin of Safety to Schloss is if the company’s book value is substantially higher than the market price. Companies get bought out that are trading at significant discounts to book.
Question: Emotional mistakes? How do you control? Answer: Schloss does not get emotional about stocks. One reason he doesn’t talk to management teams is because management presents the company the way you want to see them. Schloss is not a good judge of people. Warren Buffett is. Schloss says you have to look at situations logically, not the way you WANT to look at it.
He wants to buy things the way there are, not the way they may be in the future. He wouldn’t buy a company with a prospect of an electric car just because of that prospect.
Seems to me that he uses Good to Cancel Orders
Question: Outstanding company at a fair price or a fair company at an outstanding price? Answer: He doesn’t want to buy good companies at what they are worth – he wants to buy these companies at a discount. Sometimes people get VERY nervous and bargains arise, but that is not too often. You want to buy stocks that you can make 50% over a couple of years.
He doesn’t like to lose money. So he buys companies that are having problems. He likes companies with no debt.
Quite often the stock market reacts emotionally. Bad news causes troubles. If you are managing money for other people you should not tell your limited partners what you own – Why? Don’t want competition. Don’t want to deal with investors emotions and don’t want to hear their complaints. If LPs are worried, don’t take them as investors.
Question: Three traits to be a successful value investor? Answer: Be calm and not to be emotional. Be intellectual and look at the facts. Never get emotionally involved in a stock.
Distinguish between temporary and permanent problems.
He likes companies to be a success. If you sell early, and the stock triples, who cares? Move on.
Question: Is the upcoming recession worse than previous ones? Answer: Schloss tries to stay away from what is going on in the overall economy. He has no idea what is going on in the economy. He buys stocks on what they are worth – and not what is going on in the macro economy.
Stop worrying about what is going on in the overall economy or where the market is going – buy cheap stocks – if you go into a recession, you’ll have to wait longer to make your money. Just buy cheap stocks.
Graham liked to compare stocks that started with the same letter of the alphabet. Intellectual exercise. Compared the stocks.
Compare stocks in the same field. Two liquor companies for instance. What are their trading levels?
Question: Has market become more efficient? Answer: As an analyst, your job is to determine why one stock is selling lower than another. If an industry is having a problem, take a look. A lot more competition but that being said, “value analysts” are still not happy buying stocks that are going down.
Harder to determine when to sell versus when to buy.
Question: Personal view on diversification? Answer: Stay away from industries that are outside of your circle of competence. More comfortable with very old industries. More comfortable in stocks than bonds because inflation eats up return. Very few people become millionaires buying bonds. Bonds are for old people.
Seems to me this guy is incredibly humble. Jives with what I have read in the past.
Question: Raising capital in the 50s as a young fund manager? Answer: Not an aggressive man in going around to raise capital. Get your feet wet with family money. Very difficult to start a fund. You don’t want to lose money. If you like math, if you like investing, you can do it as long as you control your emotions.
Question: Biggest mistake? Answer: ”I forget my mistakes.” Awesome. Schloss didn’t lose money often. Never put a great amount of money in any one stock. Held over 100 stocks at any one time.
Compared value of a company versus its working capital…i.e the company was trading at 2 dollars a share but had 7 dollars of working capital per share.
Didn’t like getting involved in legal actions
Never focused on mistakes – including selling too early
Question: China? Answer: Schloss does not buy foreign companies. It is not easy to judge foreign companies. Insiders have too much advantage overseas.
Question: When to sell / mechanics of sales? “I don’t know when to sell” Schloss will sell at 100% profit. At Graham Newman will scale their sales. Will usually hold stocks for 3 years. Schloss likes profit, but he has no formula for when to sell.
If a stock gets high enough, it becomes a lot more vulnerable.
Schloss quotes from Ben Graham from the 3rd edition of Security Analysis: McDonald’s was selling at $14, down from $35. Graham’s arbitrage formula for return per year.
Question: Max you would allocate to a stock in a portfolio? If you really like, individually, you might put 20% in one stock for yourself. In a partnership, you may put only 10% in.
Shorted stocks in the tech bubble. Historically never did it before. It made him feel uncomfortable.
Question: Research – just Value Line and Annual? Answer: Less than book value, not much debt. Then you look at company itself – company might suck, but it may have a lot of book value.
Question: How do you become comfortable with an industry? He likes simple manufacturing companies. Companies might have lots of growth, but stockholders might do poorly. Simply capitalized companies. Look at the last 20 years. And then get an annual report.
Buys stocks where the outlook is not good.
Value Line: Look where stock was ten years ago.
The point is: You do not want to lose money. Buy stocks that are depressed, that aren’t going broke.
Warren Buffett – very brilliant guy – but some people were reluctant to invest because there was no income.
Question: What is the most important thing in investing and in life that you have learned in the past 50 or so years? Answer: Honesty is the best thing you could have.
Stay tuned over the next week as we analyze this Walter Schloss’ speech on value investing.
Value Investing Resources
Here I am in the process of compiling literally everything I can find on the web as it relates to Walter Schloss, Irving Kahn, and other members of the Graham – Newman Partnership. This list will continually be updated as I stumble upon more items – that being said, if you have something to share, please shoot me an email at hunter [at] distressed-debt-investing.com
Walter Schloss Resources
Schloss honoring Janet Lowe
Profiles in Investing Walter and Edwin Schloss
Schloss on Graham from Lowe’s Biography
Walter Schloss on Liquidations
Walter Schloss List of Stocks
In Defense of Stock Dividends
Intrinsic Value is Key Factor
Walter J. Schloss_Searching for Value
Schloss Seminar at CBS ’93
The Over-Valuation of Some Blue Chip Stocks
Profiles in Investing Walter and Edwin Schloss
Who is Walter Schloss – Barrons Article
The Hippocratic Method in Security Analysis
Making Money Out of Junk
Walter J. Schloss: Searching for Value
Factors needed to make money in the stock market
Walter Schloss on Liquidations
Schloss at Grant’s Interest Rate Observer Conference
Schloss: “Why We Invest the Way We Do”
Why Schloss is Such a Great Investor
Schloss on the DJIA
Walter Schloss: 1985 Barrons Article
Benjamin Graham and Security Analysis: A Reminiscence
Walter Schloss and Value Investing – Barron’s Article from 1985
August 23rd, 2010 · No Comments · Uncategorized
One of the reasons I started a value investing blog on Walter Schloss, Irving Kahn, early Warren Buffett and other members of the Graham-Newman Corporation was my fascination on how rare their early investment style is still applied today. I think we can all agree that finding 2/3 net/nets as Ben Graham prescribed is difficult. That being said, far too often we hear about GARP or EV/EBITDA versus as asset based approach so effectively employed by Walter Schloss.
In 1985, Barron’s ran a story entitled “The Right Stuff: Why Walter Schloss is Such a Great Investor.” You can find a link to the piece in our value investing resources page. In this post, like one of our earlier Walter Schloss posts on the blog, I will be using bullet points to document my notes.
Interesting point about how Barron’s had not heard of Walter Schloss until Warren Buffett blew his cover in the ever famous “The Superinvestors of Graham-And-Doddsville”
Walter recounts how he got into the business. It is interesting to note that in this interview, he says “Graham was writing his book on the stock market, and I remember helping him with one chapter.” I never knew that part of the story – this is all before Schloss had enlisted.
Very heartily recommends The Intelligent Investor
Compares Ben Graham to an undervalued security: “It’s a funny thing about Graham. I think he was like an undervalued security, if you want to know. People said, ‘Oh, Ben Graham, he’s very smart.’ But then they’d go off and do their own little thing with computers, or whatever the popular thing was at the moment. They kind of forgot. They’d say ‘Oh, we like undervalued stocks,’ but then they wouldn’t buy them.” He then goes on to point out that Graham’s ideas made perfect sense to him.
Ben Graham’s philosophy on buying a diversified pool of stocks stems from the pain he experienced during the Great Depression.
At Graham Newman they followed “the idea of buying companies selling below working capital – at two thirds of working capital – then, when the stocks’ prices went up to match working capital per share, we’d have made 50% on our money. And the firm averaged about 20% a year on that basis.” Schloss, like I noted above, then goes on to note that during the fifties, those stocks started disappearing.
Why did these stocks trade at these levels previously? “They were mostly secondary companies; they were never the top grade companies. And they tended to be ignored by the public because they didn’t have any sex appeal, there wasn’t any growth – there was always trouble with them. You were buying trouble when you bought these companies, but you were buying them cheap. Of course, when you got them too cheap, they maybe ended up going down the tubes. So you try to be a little careful. But people don’t like to buy things that are going down.”
Philosophy: “Graham liked the idea of protection on the downside and basically, that’s what I do. I try not to lose money.”
When asked what he think the market will do, his response: “I’ve got no idea; your guess is as good as mine.”
Schloss on timing: “Timing is a very – everybody tries to do it, so I stay away from the game that everyone’s trying to do. If you buy value – and you may buy it too soon, as undoubtedly I do – then if it goes lower; you buy more. You have to have confidence in what you are doing.”
Again using five years as a yardstick. But notes their average holding period is 4 years.
Liked to stay under the radar.
On his investing style: “I am a passive investor. There are people who try to be very aggressive; they try to buy companies [Editor Note: Remember this is during the LBO Boom of the mid to late 80s]. We just buy the stock, and if it goes to what we think is a reasonable price, we sell it and move on to something else. Graham made the point in his book where he said, ‘You buy stocks like you buy groceries, not like you buy perfume.’ You’re looking for value.”
No ticker tape machine in his office – he tries to stay away from the emotions of the market. The market appeals to fear and greed – He doesn’t want to be a part of that.
Blames Warren Buffett for the uprise in value investing and how hard it is to buy cheap stocks.
Gives an anecdote about a stock that Schloss purchased for the fund and then the company was bought out shortly thereafter: “But the point is, if it hadn’t worked out that way, Stauffer was a really good company, and in a few years it would have worked out satisfactory. It happened to work out quicker, that’ all.”
Doesn’t like short term gains.
On the insert lists the rationale’s for a number of his stock picks:
“The downside is limited…so you buy it”
It isn’t exactly cheap. But it’s a good value.”
“Basically a good company and there will be another deal”
“It does have problems. I can’t say that enough.”
“The timber is worth a lot more than the market price.”
“You couldn’t replace it for what it sells for.” (On Texaco)
“A good value stock. They had a terrible break.”
“There’s no particular point selling it. I have a big profit.”
“It’s got a lot of cash flow”
Note that he was managing $45M in 1987
Notes that Graham returned a substantial amount of his limited partners capital when he couldn’t find cheap stocks in 53′.
On portfolio management: “The thing is, we don’t put the same amount in each stock. If you like something like Northwest Industries, you put a lot of money in it. But we may buy a little bit of stock, to get our feet wet, and get a feeling for it. Sometimes if you don’t own a stock, you don’t pay enough attention. Then also, we sell stock on scale. Sometimes we sell some, and then stock poops out on us, and then we’re stuck.”
Continuing: “Sometimes we get into situations where we really don’t sell at all. So we have more securities than I’d like to have, and yet, I feel comfortable owning them. Then, of course, you get a situation where you buy the stock, and it seems a good value, and it goes up a fair amount, and you like it better. You become a little more attached to it, and then you see some pluses that you may not have realized before.”
The quote above confuses me: Does he mean you like the stock because it has gone up or because you’ve done more work on it and got lucky with the price action?
Adjusted Working Capital = Current Assets – Current Liabilities – Debt
Again notes about management holding stock – seems to be very import to Walter Schloss
Talk about analyzing the balance sheet: “And of course a lot of companies have lots of assets tied up in plant and equipment. Well is it an old plant, or is it a new plant?
“You don’t have to just look at book value. You can look at what you think companies are worth, if sold. Are you getting a fair stake for your money?”
Talks about a “good company” and dubs it a “not a book value stock.” (For reference, the company was selling at 10x earnings, 5.5% dividend yield, 1.5x book, 15% ROE)
Here is a very interesting quote (probably my favorite in this article): When asked why “park money” in a stock: “If the market was very low, I’d say ‘Well, CPC probably isn’t a great stock to own. If the market is so cheap, you want something with a little more zip in it, or potential.’ In a market like ours, which is not very cheap – I wouldn’t say its way overpriced, because it isn’t; it’s in a more reasonable area-there’s more risk on the downside. CPC probably doesn’t have that much downside risk, and therefore I feel comfortable with it. If the market should collapse, we, then maybe we’d sell it, assuming we’d be getting that price, and buy something that’d gone down a lot.”
Notes how he doesn’t get involved in looking at earnings potential.
Why difficult to sell? Upward price movements feed on themselves …
On holding cash: “We’ve never really done that. We’ve always been fully invested. Which may be good, and may not be good – it’s psychological. I find I’m more comfortable being fully invested than I am sitting with cash.” …very different from a number of Value Investing Legends…
Note he doesn’t play in options, doesn’t write covered calls, doesn’t short stocks
Noted that Graham thought when there were no working capital stocks, the market was overvalued…Schloss does not that theory does not really apply anymore.
Schloss on the market: “I simply say, if there are not too many value stocks that I can find, the market isn’t all that cheap.”
Simply incredible. Stay tuned later in the week when we explore more value investing articles on Walter Schloss and start digging into some securities.
Walter Schloss is considered one of the investment greats, a value investor in the same league as the Oracle of Omaha, Warren Buffet. Like Buffett, Walter Schloss was also trained under the legendary Benjamin Graham. For a brief while in the 1950s, Schloss and Buffet even shared the same office.
For sheer uninterrupted performance record, few investors can match Walter Schloss. For 45 years from 1955 to 2000, he managed the investment partnership, Walter J. Schloss Associates and delivered an astounding compound annual return of more than 15 per cent per year compared to a gain of S&P 500 of just over 10 per cent.
And this is what Buffet had to say about Walter Schloss: "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 owns many more stocks that 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."
"One of the things we've done is hold over a hundred companies in our portfolio. Now Warren (Buffet) has said to me that, that is a defence against stupidity. And my argument was, and I made it to Warren, we can't project the earnings of these companies, they are secondary companies, but somewhere along the line some of them will work. Now I cannot tell you which ones, so I buy a hundred of them. Of course, it does not mean you own the same amount of each stock."
"I'm not very good at judging people. So I found that it was much better to look at figures rather than people. I didn't go to many meetings unless they were relatively nearby. I like the idea of company-paid dividends, because I think it makes management a little more aware of stockholders, but we did not really talk about it, because we were small. I think if you were big, if you were a Fidelity, you wanted to go out and talk to management. They would listen to you. I think it is really easy to use numbers when you're small."
"Timidity prompted by past failures causes investors to miss the most important bull markets."
"We did not get involved in many companies that turned crooked. I know there were a few people that had poor reputations and their stocks were low, and when we did buy some of those we were sorry afterwards because they figured out a way of taking advantage of you, and you were always worried that they'd do something that didn't like."
"When companies have problems they often like to have their annual meetings in cities and states where there are not too many stockholders."
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