This is part three of a multi-part series on Walter Schloss, legendary value investor. To ensure you do not miss the rest of the series sign up for our free newsletter. Parts one and two can be found at the respective links below.
Walter Schloss – Part three: The Magic Of Compounding
Part three of this series starts with a letter, typed on February 3rd 1976, from an investor whose reputation had grown to the point where a rumor that the was buying a stock, was enough to shoot its price up 10%. This investor was called Warren E. Buffett and what follows is a letter he wrote to members of the “Buffett Group” before its Hilton Head conference in 1976:
Warren E. Buffett
1440 Kiewit Plaza
Omaha, Nebraska 68131
February 3rd, 1976
To the Hilton Head Group
Dear Gang,
Normally, when you get a letter from the wife, partner or secretary of Joe Glutz saying, “Of course, Joe is too modest to tell you about this himself, but I know you want to hear that…”, it means that Joe is standing over the writer with a gun at his head, telling him not to look up from the xerox machine until the mailing has been completed.
This one is for real.
Today I received the 1975 annual letter of Walter J. Schloss Associates, which included a 20-year compilation of Walter’s record since he left Graham-Newman. You may remember I went to work for Graham-Newman in 1954.
Walter left in 1955. And … Graham-Newman closed up in 1956. I would prefer not to dwell on the implications of this sequence.
In any event, armed only with a monthly stock guide, a sophisticated style acquired largely from association with me, a sub-lease on a portion of a closet at Tweedy, Browne and a group of partners whose names were straight from a roll call at Ellis Island, Walter strode forth to do battle with the S&P.
On the following page is a re-cap of his yearly performance and calculations I have made regarding compounded results. The difference between the gross results and the limited partners’ results is accounted for by the fact that, as General Partner, he takes 25% of the profits – a quaint, easy-to-calculate method of tribute not entirely foreign to many of you.
Walter Schloss has had five down years compared to seven for the S&P. His superiority in such down years would indicate that not only is he a man for all seasons, but that he has special strength when facing a head wind. Maybe all of you had better watch Ben Graham on Wall Street Week this Friday.
As for me, I’m going right out and buy some Hudson Pulp & Paper.
Best,
/s/ Warren
The above letter was not the only time Buffett wrote to his partners commending Walter Schloss’ skill. The Oracle of Omaha penned another note nearly two decades later. A copy of both letters, including Schloss’ annual returns can be found here.
It’s clear from Buffett’s correspondence that he had a huge respect for Walter. Both of the legendary investors spent time learning their trade with Benjamin Graham and both understood the true meaning of deep-value investing.
Indeed, both Buffett and Walter Schloss were cast from the same deep-value Benjamin Graham mold, but by the late 70s, early 80s the two investors were moving in different directions. Buffett for example was looking for quality at a reasonable price, buying Coke and Gillette, while Schloss stuck to his deep-value principles.
The Power of Compounding
For the 33 years ended 12/31/88, Walter J. Schloss Associates earned a compound annual return of 21.6% per year on equity capital vs. 9.8% per year for the S&P 500 during the same period. Buffett in comparison returned 23% per annum for the 24 years to 1988. As covered in part two, Schloss was under no illusion, he was not Buffett, and surprisingly, even though his returns were only 1.4% per annum lower than those of Buffett over two decades, Walter Schloss didn’t try to mimic Buffett, change his strategy, or really do anything out of the ordinary.
In fact, Schloss made it clear to investors that he wasn’t Buffett. Instead, as I covered in part two of this series, Walter Schloss made it clear that over time, while his returns may not be earth shattering, the power of compounding would accelerate returns over the long-term.
“…Peter Lynch visited literally thousands of companies and did a superb job in his picking. I never felt that we could do this kind of work…therefore, went with a more passive approach to investing which may not be as profitable but if practiced long enough would allow the compounding to offset the fellow who was running around visiting managements…”
And when you compare the returns of Walter Schloss, Buffett and Munger over the period 1962, to 1975, you can see that even though Schloss’ returns were erratic, (significantly more so than Buffett) the power of compounding over the period was the driving force behind Walter Schloss’ performance. Thanks to ValueInvestingWorld and this ValueWalk author for the chart below.
And here are Walter Schloss’ returns vs the S&P 500 from inception through to 2000. Another scenario where compounding shines through.
However, Schloss’ returns were not powered by compounding in the traditional sense. Indeed, Schloss’ fund actually returned a huge amount of cash to investors every year, [screenshot showing the distributions made throughout the life of the Schloss partnership] unlike Buffett and these distributions had not been made, it’s likely that Schloss’ returns would have been even greater than those reported above.
Still, even though Schloss’ returns were not driven by compounding in the traditional sense, his outperformance over the years is down to the fact that he knew steady growth over time and not losing money, were the two keys to long-term success. As quoted above, Schloss called this the compounding effect.
It’s No Secret
The power of compounding is no secret. Indeed, the power of compounding was said to be deemed the eighth wonder of the world but there are still plenty of investors, both institutional and private that fail to make use of this carefree method of wealth creation. Indeed, respected value investors such as Seth Klarman and Charles Brandes have recently noted that the market is now focused on short-term performance only, failing to recognize the long-term benefits of compounding or growth.
Hedge funds, mutual funds and private investors still try and outperform the market on a quarter-by-quarter basis and this is where many investors could learn from Schloss. Walter Schloss understood that he would never be the world’s best investor; he would never be able to consistently outperform the market. Therefore, Schloss stuck to what he knew and understood, only buying stocks, which conformed to deep-value criteria. The rest he left to the power of compounding.
That’s all for part three but stay tuned for part four, Walter Schloss’ 16 Factors Needed to Make Money in the Market.
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