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Monday, May 19, 2014

Walter Schloss and his balance sheet investing strategy

Walter Schloss and his balance sheet investing strategy

“I look for ways to protect us on the downside and, if we are lucky, something good may happen .We are basically passive investors. We expect corporations to treat us fairly, which, unfortunately, doesn’t always happen.”

All value investors following the fundamental approach know Benjamin Graham and his famous disciple Warren Buffett. But who is this Walter Schloss?

Who is Walter Schloss?

I first get to know Walter Schloss through Warren Buffett’s article on “the Super Investors of Graham and Doddville” from Old School Value website of Jae Jun. Schloss was a just a high school graduate but had worked under Benjamin Graham. If I were to use golf to describe Schloss, he would be “nearest to pin” in Graham’s investing philosophy.

Schloss is a low profile role model for all aspiring value investors. He is one of the most influential investors based on his 5 decade long performance from 1955, returning 20% per year, almost three times the 7% return of the S&P during the same period.

Schloss was a compounding machine that hit base hit after base hit. His investment style is mainly based on the boring, passive but highly productive balance sheet investing strategy, i.e. buying stocks at prices below its net asset value.

Schloss Investment Philosophy:

We can sum up Schloss investment philosophy in one sentence: “He buys cheap stocks”. That was precisely the cigar butt investment approach of his mentor, Benjamin Graham. He liked to look at the balance sheet more than income statement because,

“asset values fluctuate more slowly than earnings do.”

He liked to buy stocks at low price-to-book ratios, and when he did look at earnings, he liked low prices to normalized earnings.

“I 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. … Price is the most important factor to use in relation to value…. I believe stocks should be evaluated based on intrinsic worth, NOT on whether they are under or over priced in relationship with each other…. The key to the purchase of an undervalued stock is its price COMPARED to its intrinsic worth.”

Unlike Warren Buffett, Schloss practised adequate diversification because he claimed he was not a good judge of business trends or management capability (as opposed to Warren Buffett). He repeatedly said “I don’t like losing money”. So he needed to take a diversified approach so he could “sleep well”. He often owned 60 stocks or more at a time, sometimes as many as 100.

“I like the idea of owning a number of stocks. Warren Buffet is happy owning a few stocks, and he is right if he is Warren….”

Schloss invest with a long-term view. He did not expect his investment strategy yielding results in a short time. He often owned his stocks for an average of 4 years.

“Don’t buy on tips or for a quick move.”

Unlike Philip Fisher who is the pioneer in scuttle-butting, talking to the management, the staff of the company, customers, suppliers etc when doing his investment, Schloss rarely talked to management, choosing to invest only on the numbers.

“We aren't too good, generally, in interpreting what managements say, assuming we get to top management rather than stockholder relations people.”

“In thinking about how one should invest, it is important to look at you strengths and weaknesses. …I’m not very good at judging people. So I found that it was much better to look at the figures rather than people.”

Schloss’s approach was passive, methodical and common sense investing. He provides a road map for long term success. Buy value, diversify adequately, be patient. He said that while others had higher rates of returns at times, he was able to outlast them, and thus achieve a longer track record because his style of investing was enjoyable and easy to maintain. Schloss’ style of investing could be replicated by most people, if they have the temperament and patience that Schloss had.

“I don’t like stress and prefer to avoid it, I never focus too much on market news and economic data. They always worry investors!”

Schloss is an example that investing success can be achieved through a methodical application of simple, replicable investing principles.

Appended below is a must read article by Walter Schloss, “Why we invest the way we do?”

C Chong (18 May 2014)

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