This is part seven 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 six can be found at the respective links below. Also check out these great books on Walter Schloss; Value Investing: From Graham to Buffett and Beyond by Bruce Greenwald; The Memoirs of Walter J. Schloss: A Personal and Family History by Walter Schloss; A Modern Approach to Graham and Dodd Investing (Wiley Finance) by Thomas P. Au.
Walter Schloss – Part seven: Learning from the Master
As I’ve covered before, Walter Schloss never went to college. At 18, he started working as a runner on Wall Street at Carl M. Loeb & Co. After a year at the firm, Walter Schloss met with Armand Erpf, a partner of Loeb & Co, who was also incharge of the statistical department. Walter Schloss wanted a job in the statistical department but Armand turned him down. Instead he advised Schloss to read a newly published book entitled “Security Analysis” written by Benjamin Graham and David Dodd
After reading the book, and looking to further his career, Schloss enrolled on a series of courses conducted by the New York Stock Exchange, prerequisites for classes with Graham. After these primers, Walter Schloss was allowed to take a course in “Security Analysis” as taught by Graham.
Articles seven and eight of this series on Walter Schloss are based on what Schloss learned from Graham during his time with the Godfather of deep-value.
Figures only
Most of the following text is taken from a lecture Walter Schloss gave at Columbia Business School during November 1993. The full text can be found here.
“…Ben would like to take companies that appeared close in the alphabet and compare them statiscally. I remember specifically Coca-Cola and Colgate Palmolive where he showed statistically how much cheaper Colgate was than Coke and he compared Dow Chemical to Distiller Seagram (now Seagrams) in which Seagrams was much cheaper…”
These four companies Graham compared are from different industries, with different background and outlooks. This made no difference to Graham. Walter Schloss explained why in an interview gave with his son, Edwin Schloss:
“ES [Edwin Schloss]: How do you compare two different companies in different industries?
WS: He was using the statistics. He wasn’t using industry analysis. He was using the value of the company. He was looking at relative value to see if the company was relatively cheap to book value.”
In fact, Graham paid little attention to company specific factors:
“Ben didn’t look for franchise value or managements. He felt that management showed up in the price of stock. If management was good the stock sold at a higher P-E because its management was better. Basically Ben didn’t want to lose money. He had a rough time during the depression and in 1938 to 1940 [Graham was reportedly wiped out by the market crash, although he preserved his investors’ cash] when I took his courses, he was looking for protection on the downside…I guess I still look at stocks with the idea of not losing money…if you don’t like to lose money and it affects your judgement, don’t buy things that can go down a great deal…Ben Graham didn’t visit managements because he thought the figures told the story…”
To understand this statement you have to do some digging. Graham was quite literally an intelligent investor, and other investors came to realize this. However, Graham needed to prove his skill on Wall Street and to do this he took on a level of risk.
Wiped out
When Graham started managing money in the 20s, in order to attract capital and gain the trust of his investors, Graham made an agreement with his partners whereby he would take 50% of partnership profits, but also 50% of any losses at the fund. In the words of Walter Schloss:
“…And that worked great until 1929 when the market went down and obviously his stocks were affected, too, and he was not only affected by that, but many of these people then pulled out because they needed money for their own purposes or they had lost money in other places.”
“So he figured out how he could possibly never have this happen to him again. He was very upset about losing money. A lot of us are. So he worked on a number of ways of doing this and one of them was buying companies below working capital…then in 1936 he formed a company called Graham-Newman, which was, I’d say an open and closed end company…he’d sell stock with the rights to buy new stock below asset value. That is, if you didn’t exercise your option you were able to sell the rights for money.”
Jumping back to the Columbia Business School lecture:
“When Ben was operating in the 1930s and 1940s, there were a lot of companies selling below their net working capital (NET NET). Ben liked these stocks because they were obviously selling for less than they were worth but in most cases, one couldn’t get control of them and so, since they weren’t very profitable, no one wanted them,. Most of these companies were controlled by the founder or their relative and since the 30s was a poor period for business, the stocks remained depressed. What would bring about change?”
As it turned out World War Two was the catalyst needed to unlock value for many of Graham’s net-nets opportunities. To find out why, stay tuned for part eight of this series where I’m going to take a look at Walter Schloss’ time at the Graham-Newman partnership.
The post Walter Schloss Part Seven: Learning From The Master appeared first on ValueWalk.
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