This is part four 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 to three can be found at the respective links below.
Walter Schloss – Part four: 16 Factors Needed to Make Money in the Market
The first few articles of this series have been devoted to Walter Schloss’ style of investing. It’s clear that Schloss was never looking to be the next Buffett but when it came to investments, he always knew where to look for the next bargain.
Indeed, Schloss stuck to a strict set of rules when he was making his trades, and as I’ve covered before, Walter Schloss invested purely on balance sheet analysis and valuation metrics that he knew and understood. Walter Schloss never visited the management teams of the companies he invested in and if he couldn’t understand something, he would stay away.
Of course, Walter Schloss’ experience came from decades of market analysis and a well-developed understanding of how the market worked; traits that can only be taught by experience. But to help new investors, Walter Schloss put together a list of 16 principles for becoming a better investor. These principles were published by Schloss on a one-page note to investors dated March 10, 1994.
The original note can be found here and there’s a screenshot of the note below.
Walter Schloss: 16 Factors Needed to Make Money in the Market
- “Price is the most important factor to use in relation to value.”
Factor number one is fairly self explanatory. In the words of Warren Buffett: “price is what you pay, value is what you get.” Getting the right price is essential to unlocking 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.”
This is an important factor in setting your frame of mind for investing. As taught by Benjamin Graham, every investor needs to understand that under every stock, there’s a business. Just because the stocks falling, it doesn’t meant the company’s in trouble.
- “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).”
Fairly self explanatory. Buying below book is key for value investors and high levels of debt can strangle business growth.
- “Have patience. Stocks don’t go up immediately.”
Don’t rush things. It could take years for value to be realized. Remember for every stock there’s an underlying business and businesses don’t double profits overnight.
- “Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.”
Buying on tips, or for a quick move, is speculating as you are betting that the price of the stock will rise. Invest in a series of cash flows, don’t speculate on a higher price.
- “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. Buy on a scale and sell on a scale up.”
Look for weaknesses in your thinking. As Warren Buffett’s partner, Charlie Munger says, “invert, always invert.” Examine the variant perception and the bear case if you’re long a company. The best investors focus on the downside even more-so than the upside. What’s the risk of the company going out of business?
- “Have the courage of your convictions once you have made a decision.”
Don’t falter in your decisions, don’t flip-flop from company to company buying and selling according to hunches. Stick with your decision and run with it.
- “Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.”
- “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 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. If the stock market historically high. Are people very optimistic etc?”
Walter Schloss always sold after a 50% profit to lock in gains. Peter Cundill, another famous value investor, decided that his fund would automatically sell half of its holding in any one security after it had doubled.
- “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.”
How much lower can the stock go?
- “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.”
This is especially true in cyclical sectors, the oil industry is a great example right now.
- “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.”
Listen to other opinions, always have an open mind.
- “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 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.”
Explored further in part three of this series.
- “Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.”
During the ten years ended on September 30, 2014, the S&P 500 – a measure of performance for large U.S. companies – registered an average annual total return of 8.11%. In comparison, the domestic bond market, as gauged by the Barclays Aggregate U.S. Bond Index, had an average annual return of 4.62%. Source.
- Be careful of leverage. It can go against you.”
“When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious…But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade — and some relearned in 2008 — any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.” – Warren Buffett
So those are Walter Schloss’ 16 factors needed to make money in the stock market. A copy of the original document is pictured below. Stay tuned for part five!
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