The late Walter Schloss is one of my investing heroes. And, he is quite possibly the best investor you have never heard of. In 1946, Schloss started working for the legendary investing sage Benjamin Graham. Over time, Schloss became an investing master himself. After nine years under Graham, Schloss set off on his own in 1955 to start managing money for outside investors. What followed were a few decades of success. From 1956 to 2000, Schloss’s US-based fund generated a compound annual return of 15.3%, enough to turn a $1,000 investment into $525,000. For perspective, the US stock market experienced…
The late Walter Schloss is one of my investing heroes. And, he is quite possibly the best investor you have never heard of.
In 1946, Schloss started working for the legendary investing sage Benjamin Graham. Over time, Schloss became an investing master himself. After nine years under Graham, Schloss set off on his own in 1955 to start managing money for outside investors.
What followed were a few decades of success. From 1956 to 2000, Schloss’s US-based fund generated a compound annual return of 15.3%, enough to turn a $1,000 investment into $525,000. For perspective, the US stock market experienced a return of only 11.3% annually over the same period.
I find Schloss to be a fascinating investor because of the way he invested. Fancy math, complex valuation models, and arcane market-forecasting techniques – he depended on none of these. All he did was to find stocks that were selling for far lower than his appraisal of their intrinsic business values (Schloss relied mainly on a stock’s asset value for this). His office was just a rented closet space, and his investing ‘team’ consisted of just two people – him and his son, Edwin, who joined in the 1970s.
Schloss wrote a short memo in 1994 titled (link opens PDF) Factors needed to make money in the stock market. The memo contained 16 rules Schloss relied on while investing. Let’s take a look at those golden rules.
1. “Price is the most important factor to use in relation to value”
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.”
Investors can get into trouble when they forget that stocks represent part-ownership of a company.
One great example involves Blumont Group Ltd (SGX: A33). The company was part of an infamous trio of penny stocks that collapsed spectacularly over the course of a few days in October 2013.
From August 2012 to September 2013, Blumont’s stock price climbed nearly 4,000% from S$0.06 to a high of S$2.45. Somewhere near its peak, the company was actually valued at 500 times earnings and 60 times book value.
Those were crazy valuations that could not be backed up by any business fundamentals whatsoever. Investors who forgot that a share represents a piece of a business back then would end up paying a dear price. Today, Blumont’s stock price is S$0.004.
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).”
Debt can really kill companies, so do watch out for the level of debt a company has. Some recent high-profile cases of bankruptcies in Singapore’s stock market are Swiber Holdings Limited (SGX: BGK) and Ezra Holdings Lmited (SGX: 5DN) – both were victims of debt.
4. “Have patience. Stocks don’t go up immediately.”
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.”
6. “Don’t be afraid to be a loner but be sure that you are correct in your judgement. You can’t be 100% certain but try to look for weaknesses in your thinking. Buy on a sacle and sell on a scale up.”
7. “Have the courage of your convictions once you have made a decision.”
8. “Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.”
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 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? Is the stock market historically high? Are people very optimistic etc.?”
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 show that there is some vulnerability in it.”
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 much more about a company if one buys earnings.”
The blue chip stock Sembcorp Industries Limited (SGX: U96) provides a great example of how fast a company’s earnings can change as compared to its assets.
Source: S&P Global Market Intelligence
As the table above shows, over the timeframe stretching from 31 December 2014 to 31 December 2016, Sembcorp Industries’ book value per share has grown slowly but steadily. Its earnings per share however, has swung wildly.
A smart point’s being made here by Schloss: While it can make sense for investors to focus on a company’s earnings when making an investing decision, it has to be coupled with a good understanding of the business. Failure to do so can result in pain.
12. “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 lost a lot of money it is hard to make it back.”
13. “Try not to let your emotions affect your judgement. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.”
14. “Remember the work [sic] 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.”
Schloss and Warren Buffett first met when they were both working for Graham. Buffett is currently 86 years old and has a net worth of around US$74 billion, as estimated by Forbes. Over 99% of Buffett’s current wealth came after his 50th birthday. Oh, the sweet magic of compounding.
15. “Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.”
16. “Be careful of leverage. It can go against you.”
Leverage can be a wonderful thing when the tide’s with you. But when the tide turns, leverage can kill. Even the smartest of investors can get crushed from the use of borrowed money to invest.
The hedge fund Long-Term Capital Management is a great example. It was full of bona fide geniuses (there were many PhD holders working in the fund along with two Nobel Prize winners, Robert Merton and Myron Scholes ), but the fund collapsed within four years of its founding and had to be bailed out by the New York Federal Reserve. It’s not hard to see why the fund had failed – It was leveraged to the hilt, borrowing up to $100 for every dollar of asset it had.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.