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Inside The Mind Of Walter Schloss

Steve Pomeranz, value investing

One Of The Greatest Gurus Of Value Investing

Everyone has heard of Warren Buffett and perhaps a few of you know some other names like Peter Lynch from Fidelity and John Templeton from the Franklin Templeton Funds, but I bet most of you have never heard about the legendary stock-picker, Walter Schloss. Schloss was one of the world’s best investors of all time, despite never having even touched a computer or used the Internet. Schloss died in 2012 at the ripe old age of 95,  so let’s find out some more about him and start at the beginning.

Schloss never attended college, and at the young age of 18 he started out as a “runner” on Wall Street… a runner was someone who literally ran the orders from the brokerage firm to the trading floor. Then World War II struck and after Schloss served his time of duty he returned to his passion and went back to Wall Street. Schloss decided to educate himself on the business of stocks through courses offered by the New York Stock Exchange, and (get this!) was lucky to have legendary value investor Benjamin Graham as one of his teachers. Of course Ben Graham was the biggest influence on Warren Buffet and others and is considered the Father of Securities Analysis. Schloss excelled at this because he then went to work for the Graham-Newman partnership where he honed his investing skills. And, in 1955, he founded his own firm: Walter J. Schloss Associates – where he racked up one of the best records in investing history until his passing in 2012. When he decided to close his firm in the early 2000s, his record stood at a compound average annual return of 16% per year over a 40 year career – that’s pretty astounding! To put that in perspective, that’s the equivalent of turning $100,000 into $38 million over a 40-year span – pretty remarkable!

Book Value and Honesty

So how he achieved such spectacular returns was the result his investing style which was based on the value investing techniques developed Benjamin Graham. As Walter put it so simply, “we buy cheap stocks.” While the concept sounds overly-simple, what he really meant to say was “we buy stocks cheap”… and by cheap, he didn’t mean buying up the cheapest stocks in terms of price, but buying stocks that were selling well below their intrinsic or book value.

In an interview he gave to Forbes many years ago, he said, “I focus on assets. If you don’t have a lot of debt, it’s worth something.” Aside from buying firms below book value, Schloss looked at the management of a company and whether they were overly greedy or honest. While he did not personally visit each company, he relied on his observations and analysis of how management ran the business over time… and that gave him a good prediction of whether the business would or would not prosper in the future.

And, ultimately, he found the combination of honest management and buying at a large discount to book value turned out to be a very powerful combination.

“Own It”

While investing in stocks with honest management and a low price relative to book value was key to his success, he also understood the importance of adequately diversifying his holdings, stuffing over one hundred companies into his portfolio. In fact, if he saw a good opportunity, he just had to buy it. As he stated in an interview in 2003, “the important part is to have some money in the stock. If you don’t have any money in a stock you tend to forget about it.” And that is so true… so where he saw value, he added the company to his portfolio, and committed himself to following the company.

Schloss was also firm in his convictions. In fact, as a contrarian, Schloss was also famously fine with Warren Buffett’s criticism that diversification was protection against ignorance. In fact, in one of his talks, Buffett went on to praise Schloss’s stubbornness, saying “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.”

But I give credit to Buffett for being so generous, because over-diversification and over-confidence in one’s abilities, coupled with a lack of understanding about the underlying nature of each business you’re invested in – is mostly a recipe for investing disaster. But, somehow, Schloss had the magic touch.

Stick to What You Know

That said, his zeal for diversification mostly stopped at America’s borders. For the most part, he was apprehensive of investing in foreign companies and was just not comfortable with the risks where language was also a barrier. So his global diversification mainly focused on a handful of British companies that he understood and was comfortable with. And I think that’s a valuable takeaway from Schloss’s investing style. If you speak and understand the culture and politics of another country, and are comfortable investing there, then go ahead. However, like Schloss, 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 finding other places to invest in. And believe me, there are plenty of places to invest in.

Sell When the Time is Right

Now, one of the biggest challenges in investing is knowing when to sell. It’s simple enough to tell which stocks are cheap on a statistical basis, and which have characteristics associated with outperformance, but knowing when to sell is another matter entirely. For example, if you buy a depressed company – it’s not going to go up right after you buy it… in fact, chances are it’ll go down first (simply because almost no one can consistently call the bottom in all the stocks they invest in)… so you have to wait a while for your investment thesis to play out.

Schloss delivered outstanding results year-after-year – partly because he never got overly greedy. If stocks he owned rose to where he thought they’d peaked in “value”, he’d close out his position and book his profits- without trying to ride the stock out higher… because, to him, that moved out of the realm of capital preservation and value investing and into the realm of capital risk and speculation. This was a highly valued notion from Ben Graham as well. So Schloss always preferred a solid sale to holding out for greater gains that may or may not be realized. Ultimately, Schloss believed that if you buy cheap relative to value and then hold on long enough, a depressed company will ultimately turn around and make you a decent profit. Of course, remember he liked companies with little or no debt on their balance sheets so he could afford to wait as long as it took.

Walter didn’t have a target price to sell, per se. For Walter, the right time to sell was when the company was no longer cheap.

Now… while Walter Schloss’s investing style may sound easy enough to replicate… it really isn’t for most individual investors – because investment success takes a unique combination of analysis, confidence in holding temporarily losing positions, sticking with your thesis, not giving in to emotion, and knowing when to sell. But there is much to be learned by following great investors and incorporating some of their techniques into your investment ecosystem. To find out more about Walter Schloss’s investing style, google his name to find many articles and wonderful books describing the techniques of America’s legendary Stock pickers.