Honoring Walter Schloss
Cover Story, by Mark Robertson, Managing Partner October 1st, 2012
This month, we celebrate his approach to investing -- including a nod to Warren Buffett (Ben Graham) and Value Line.
Long-time readers are somewhat familiar with the exploits and achievements of the late Walter Schloss (August 28, 1916 – February 19, 2012). This month, we celebrate his approach to investing — including a nod to Warren Buffett (Ben Graham) and Value Line. We’ll briefly explore the drivers behind our focus on the Value Line low total return forecast. Value Line is good enough for Buffett who wrote about the achievements of Walter in his work, The SuperInvestors of Graham-and-Doddsville. In addition to the investing guidelines detailed here, Schloss relied extensively on Value Line. In Buffett’s words, “Schloss practiced investing in a way that any ordinary investor can.”
“Over 39 years of investing had delivered annualized returns of slightly over 20% to the clients of Walter Schloss. He worked entirely from a few publications like Value Line …” — Warren Buffett, “The SuperInvestors of Graham-and-Doddsville”
Value Line Investment Survey Low Total Return Forecast (1999-Present). Was the faith in Value Line held by Walter Schloss misplaced? Why does Manifest Investing focus on the low total return (VL LTR) forecasts at Value Line? We think Walter’s faith was well-founded and that Value Line has the potential to deliver outstanding opportunities as a trusted resource. Since 1999, the average quarterly low total return forecast for the Standard Edition has been 8.5%. The actual quarterly returns have been 8.6%. We think it’s a really good idea that MANIFEST PAR tracks LTR, in general.
Schloss shared the following investing guidelines in a presentation dated March 10, 1994. As we’ve said before, and we’ll be happy to repeat — when an extremely successful investor with a track record that spans more than five decades says, “Listen up. This is what is important.” We listen.
1. “Price is the most important factor to use in relation to value.”
Price is an important component of the return forecast equation. The expectations we build for the companies we study necessarily seeks superior returns. We’re here for the returns. Superior long-term performance depends on the discovery of better returns — based on attractive prices.
2. “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.”
“When you buy a stock, you become an owner of the company. There is just as much reason to exercise care and judgment in being an owner as in becoming a shareholder.” — Benjamin Graham
3. “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).”
The value of any enterprise is a combination of book value and the discounted value of a future stream of cash flows. Remember that capital structure is a management decision — and that we expect our leaders to prudently pursue the optimum blend. That said, a company steeped in debt makes interest payments and in the case of failure, common stock holders are often deserted. It’s quite a challenge for a company to go bankrupt with no debt — prudent advice for beginning investors.
4. “Have patience. Stocks don’t go up immediately.”
Patience. Discipline. Good advice.
5. “Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.”
Do diligence. Pun intended.
Value Line Forecast Efficacy (1999-Present). This graphic profiles the collective low total return forecasts for the Value Line Investment Survey. The green bars represent quarterly four year forecasts based on the 3-5 year median projected low total return. The blue graph provides the actual results four years later. As shown, the second bar from the left represents the 6.1% low total return forecast on 3/31/2000. The second blue dot from the left on the line graph is the actual returns realized for the trailing four years ending 3/31/2004 — the forecast period. The average forecast and average actual result is 8.5% with periods of optimism and pessimism from 1999-present.
6. “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 weaknesses in your thinking.”
What are the threats to your assumptions for growth, profitability and valuation? Have you digested the bulls case vs. the bears case from sources like Morningstar? How about the 5-and-3 influences discussion from sources like the Motley Fool Stock Advisor.
7. “Have the courage of your convictions once you have made a decision.”
Do you believe that our approach to understanding the trends associated with growth, profitability and valuation work? If so, let them work.
8. “Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.”
We know that our mettle will always be tested. The discipline of building expectations and vigilantly monitoring for threats and opportunities with respect to a few key factors makes it easier to adhere to our convictions and philosophy. It doesn’t hurt to have the peer pressure and source of ideas from a community of like-minded investors, either.
9. “Don’t be in too much of a hurry to sell. 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 reevaluate the company again. 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?”
Buy. Hold. For as long as it makes sense to do so?
We think the analysis should be a CONTINUOUS process. Is your return forecast for any stock below money market rates. Market levels? With respect to market barometers, what is the median return (MIPAR) for all stocks? Does your overall portfolio PAR need bolstering? If not, don’t hurry.
But if it is, don’t wait.
10. “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.”
NAIC co-founder George Nicholson also liked to monitor trailing period low prices, usually 3-5 years.
Stock prices fluctuate.
The key takeaway is to de-emphasize stock price. Heed the chronicle of return forecasts. Keep your eye on the projected returns.
11. “Try to buy assets at a discount than to buy earnings. Earnings can change dramatically in a short time. Usually assets change slowly. One has to know how much more about a company if one buys earnings.”
Earnings and P/E ratios are the staples of the underperforming rhino playground. Earnings fluctuate. Stock price follows earnings — but the focus should be on long-term trends.
Build an understanding of (1) the top line and growth, (2) the profitability trend and (3) the valuation characteristics — particularly as a function of life cycle and industry-specific tendencies.
We don’t buy earnings streams. We invest and own successful enterprises.
MANIFEST 40: September 2012. Our quarterly summary of the (40) most widely followed stocks by Manifest Investing subscribers. Apple (AAPL) finished its ascent up the list, dislodging Stryker (SYK) from the pole position. The outperformance accuracy of the MANIFEST 40 is 69% with an overall relative return (alpha) of +4.9%.
12. “Listens 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.”
We agree. We respect the achievers all around us. As a case in point, the relative return (alpha) of our quarterly summary of the (40) most widely-followed companies by MANIFEST subscribers (shown here) is +4.9%.
We believe in the wisdom of communities and our experience has been that this is a place where ideas are born.
13. “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.”
Incomparable advice. We believe that the comprehension of return forecasts (PAR) based on the major milestone judgments (growth, profitability and valuation) and quality enable patience and discipline.
14. “Remember the word 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.”
Stay invested. That doesn’t mean stay 100% in stocks at all times. It is OK, highly desirable, to hold cash equivalents for as long as it takes to shop. Near market tops, we think selectivity is important and opportunities should become more scarce.
Incremental impact matters. Using the +4.9% relative return of the MANIFEST 40 as an example. $100 invested for 40 years at 8.0% attains a value of $2172. Achieving 12.9% over that same 40 years turns $100 into $12,816. Every percentage point increment matters. Big.
15. “Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.”
True. But carefully consider balanced investing and asset allocation when you’re ready.
16. “Be careful of leverage. It can go against you.”
Two words. Great Recession. What was so great about it? Speaking of great … Thanks, Walter Schloss, for these 16 nuggets. He showed us that superior performance is possible and told us how to do it.
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.