One Wall Street legend did it all without ever having touched a computer or accessing the internet.
Walter Schloss was one of the most successful investors of all times, but very few outside the close circuit of value investors know about his investment exploits.
(Masters of the Markets: Read up other investing strategies and trading tips from market greats)
Born in August 1916, Schloss had no formal qualifications and began working as a runner on Wall Street in 1934 before serving in the US Army Signal Corps. He eventually became a notable follower of the Benjamin Graham School of Value Investing, after he took investment courses taught by Benjamin Graham at the New York Stock Exchange Institute.
Later, he worked for Mr Graham in the Graham-Newman Partnership, where he also happened to meet Warren Buffett.
In 1955, he founded his own firm: Walter J Schloss Associates, where he racked up one of the best records in investing history until he passed away in 2012. In his over 40 year career as an investor, Schloss compounded his money at 16% year after year, a record that is still difficult to match for the best of investors.
In 1984, Warren Buffett named Schloss one of the great ‘Superinvestors’ and said, “He knows how to identify securities that sell at considerably less than their value to a private owner. He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over and over again. He owns many more stocks than 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’s one of his strengths; no one has much influence on him.”
Investment philosophy
Schloss had the knack for picking stocks when they were hitting new lows and the ones trading at prices lower than their book values per share. Besides buying stocks of the firms below book values, he also looked at a firm’s management to check whether they were overly greedy or honest.
This information helped him know how the management ran the business over the years and gave a good prediction whether the firm’s business would prosper in the future.
Schloss believed it was better to buy stocks than bonds because of their growth potential. He also limited his holdings in one stock to no more than 20% of his entire portfolio. But at any given time, he was never shy of holding up to 100 different stocks in his portfolio.
He weighted his holdings based on their perceived values, putting less money in positions he was less sure about. He used limit orders to purchase stocks, so that he could decide on the price he was willing to pay.
Walter Schloss has left behind a library of investment wisdom, which is relevant to this day.
- Don’t try to time the market
Schloss said many investors loved to forecast the direction of the market and make predictions, which often landed them in deep trouble. He said one should realise that it was almost impossible to time the market and make accurate predictions.
“I am not good at timing the market. So when people ask me where I think the market is doing, their guess is as good as mine,” he said in an article Setting the Right Pace.
- Don’t trust the management
Schloss said investors shouldn’t believe the promises made by a company management and shouldn’t trust earnings projections.
“I really have nothing against earnings, except that in the first place earnings have a way of changing. Secondly, your earnings projections may be right, but people’s idea of the multiple has changed. So I find it more comfortable and satisfying to look at book value. Earnings are much more likely to fluctuate than book values, and therefore, estimating longer term earnings than, say, the next year’s or so can be subject to serious error,” he said.
- Don’t let emotions affect your investment decisions
Schloss believed weak emotional intelligence could be deadly for an investor’s career. If an investor had weak emotional intelligence, they would find it very difficult to take advantage of a good opportunity and buy value stocks. Also, they wouldn’t be able to hold onto the stocks when they dip.
“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. You have to have a strong stomach and be willing to take an unrealized loss,” he said.
Schloss said investors should learn to get detached from the day-to-day noise of the market, which could help them control emotions and make better investment decisions.
“I try to be removed from the day to day; I don’t have a ticker-tape machine in my office. I try to stay away from the emotions of the market. The market is a very emotional place that appeals to fear and greed, all these unpleasant characteristics that people have,” he said.
- Invest only in your circle of competence
Schloss said it is important for investors to only invest in areas that they understood and were comfortable with.
“If you are not comfortable and do not have a basic understanding of the area you’re looking at then it’s probably best to learn more before diving in, or just find other investments,” he said.
- When to buy or sell a stock
Schloss said one of the biggest challenges that any value investor faced was not knowing when to sell. He felt it was quite simple to tell which stocks were cheap statistically, and which might have the traits of outperformance, but knowing when to sell was never easy.
He followed a general rule of thumb where he used to aim for a 50% profit from any stock before selling. Sometimes the stocks continued to rise after he sold them, but he tried to keep his emotions in check and stuck to his decision.
Schloss believed if investors buy cheap relative to value and then hold on long enough, a depressed company was bound to turn around and make a decent profit. He felt if a stock’s price was falling and the company’s fundamentals were sound, then investors could buy more of that stock.
“When you buy a depressed company it’s not going to go up right after you buy it, believe me. It’ll go down. And therefore you have to wait a while for that thing to go around,” he said.
Schloss made a checklist for initial consideration before buying a stock of a company. The stock should possess-
- A good ten-year track record
- No long-term debt
- A low price-to-book-value ratio
- Price at or near its 52-week low
- High insider ownership
- Keep a diversified portfolio
Schloss says having a diversified portfolio was incredibly important as in the long term. He advised investors to limit holding of one stock to no more than 20% of the entire portfolio. Also, he felt investors could diversify their portfolio with up to 100 stocks.
Schloss also looked at some value traits in a company before investing in them.
Companies with real assets with little or no debt, providing a margin of safety in case the company liquidates.
- 20% or more discount to book value.
- A good dividend yield.
- Managements that own a lot of stock.
- Honest management that does not overpay itself.
In a lecture on how to make money in the stock market for young investors and those without in-depth knowledge of the value investing process,
Schloss once came up with a 15-point guide:-
- 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.
- When buying a stock, buy near the low of the past few years.
- Try to buy assets at a discount rather than to buy earnings. Earnings 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 word compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 years, 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.
Schloss stressed on focusing on assets rather than earnings, unlike Warren Buffett’s investing style which requires the ability to identify a competitive advantage and doing a thorough research on a company’s financial statements that most people have a hard time comprehending.
Many investors often invest in a company based on its annual earnings, but Schloss had proved that they were more likely to succeed if they focused on the assets on the balance sheet. Schloss’ investing style is a time-tested one that holds true even today.
(Disclaimer: This article is based on various interviews of Walter Schloss)
