When you think of investing, the first name that comes to your mind is Warren Buffet- and with good reason. Buffet has a legendary track record and has generated very high returns for his investors since the ’60s. But a lesser-known investor who was just as good and referred to as ‘Big Walt’ by Buffet is Walter Schloss, one of the most legendary investors in the investment world.
Walter Schloss’ investment theories are most applicable to small value investors and were based on the teachings of Benjamin Graham (another icon in the investing world and also known as the father of the value investing).
Schloss’s studies helped gain an insight into how to perform deep value investing that is still relevant in today’s market. While the basis of Walter Schloss’s principles were based on Graham, he developed his own strategies while staying close to the fundamentals. His theories earned him the title ‘Superinvestor’ in 1984.
The Investing Playbook
Walter Schloss’ investment strategies involved a more ‘play by the book’ approach of investing in undervalued stocks. He focused on the quantitative factor and instead of following every stock he owned, Schloss decided to follow stocks based on valuation and buying at a discount to the intrinsic value. In 1994 Schloss listed the factors he believed were required to make money on the stock market. I have discussed the most important factors below:
1. Price is the most important thing when it comes to buying stocks
Walter Schloss’ believed Ben Graham’s philosophy that ‘a stock well bought is half sold’. He felt that every stock will become an attractive buy at a certain point as long as the price dropped low enough to provide a safety margin.
2. The price of a stock in relation to its book value is the most important factor in valuing stocks
Walter Schloss never bought stocks that had a premium to book value ratio. Instead, he bought it at a discount to book value as it provided a margin of safety. The investors who remained patient in the short run would be rewarded in the long run if they systematically bought discounted stocks.
3. Buy stock in companies that have been in business for a while
Schloss preferred to invest in stocks of companies that have a long history of being in business. The fact that these businesses have been in operation for so long gives the investor the confidence that the company will continue to operate long into the future as well. It can also help identify their business cycle and compare the book value earnings. Walter Schloss’s also invested in companies that were going through a downturn in their business cycle if he believed that the asset portfolio was strong and the chances of the company performing well in the long-term seemed favorable.
4. Maintain a diverse asset portfolio and stay fully invested
Walter Schloss usually traded a 100 different stocks at any given time and he was a 100% invested. During a high market valuation, he would adjust his price to book value upward if the company was paying a good dividend. But he relied on dividends rather than earnings as an indicator of a company’s profitability.
When analyzing the quality of the management in the company you choose to invest in, Walter Schloss believed that being ethical was more important than just being smart. In an interview, he said: “In a choice between a smart guy with a bad reputation and a dumb guy, I think I’d go with the dumb guy who’s honest. Of course, you can’t always protect yourself there, either. I guess the choices we’ve made are probably in those areas.”
The ‘rules of investing’ were written by Walter Schloss many years ago but they still remain relevant today. If an investor learns to stick to a small value approach, it will benefit them in the long run. Keep it simple.
Walter Schloss and Portfolio Management
Walter Schloss did not invest too much time assessing the details of a particular stock to the very last detail rather he studied the company financials and did not overanalyze each investment opportunity. He spread his risks evenly and sometimes invested just $10,000 in a stock. His portfolio consisted of a hundred stocks.
In the initial investment, Schloss would take a small position and eventually buy more if the difference between the trading price and intrinsic value continued to widen. In particular, he preferred to invest in companies with a higher margin of safety and focused on stocks with low leverage.
Walter Schloss’s deep value investing
As a small value investor, the strategies used by Walter Schloss are extremely relevant. Walter Schloss’s investment strategy was incredibly old-school, he was a simple man and operated more like a small-time investor rather than a professional financial advisor. Schloss never aimed to reach new heights as an investor and continued to use and search for new deep value investing ideas till the very end.
Value investing are stocks that trade lower than their book value and while it is hard to find these stocks in today’s market where ‘money never sleeps’, this old school strategy developed by Walter Schloss is still important. Here are the key takeaways of this investing style:
- The main criteria of the investor should be to discount your stock to a tangible book value
- The quality of the management is also important, if the company is not confident in their management, then neither should you
- Having a diversified portfolio is incredibly important. In the long term, it is the valuation of your portfolio that helps you earn large gains in the stock market.
BONUS: 16 Investing Rules from Walter Schloss
(FROM A 1994 LECTURE)
- Price is the most important factor to use in relation to value.
- 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.
- Use 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).
- Have patience. Stocks don’t go up immediately.
- Don’t buy on tips or for a quick move. Let the professionals do that if they can. Don’t sell on bad news.
- Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.
- Have the courage of your convictions once you have made a decision.
- Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
- Don’t be in too much of a hurry to see. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate 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? If the stock market historically high. Are people very optimistic etc?
- 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. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.
- Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings.
- Listen to suggestions from people you respect. This doesn’t 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.
- 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.
- Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
- Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
- Be careful of leverage. It can go against you.
The Walter Schloss investing style is great for anyone looking to invest in small companies. The strategies help reduce risk with the promise of high returns.
Unlike Warren Buffet’s investing style which requires the ability to identify a competitive advantage and do thorough research into a company’s financial statements that most people don’t have the know-how to do. Schloss provides a great alternative to this- focus on assets rather than earnings.
Many small investors are in the habit of solely investing in a company based on its annual earnings but they are more likely to succeed if they focus on the assets in the balance sheet. Walter Schloss investing is a time-tested lesson that still holds true today.