Walter Schloss Debate With Charles Ellis On Stock Buybacks

Walter Schloss was one of Benjamin Graham’s most successful students. From 1955 through 2002, Schloss returned 16% per annum, according to his own figures, successfully using Benjamin Graham’s net-nets strategy to outperform the market for five decades.

Walter Schloss didn’t give many interviews over his career, but he did write a number of memos and letters to various publications over the years.

Walter Schloss: Heated exchange

Below is an example of one such letter, or series of letters. This was an exchange between Schloss and Charles D. Ellis, Financial Analyst for Rockefeller Brothers, Inc.

Schloss disagreed with Charles D. Ellis’s view on buybacks, arguing that if a company’s shares were trading below net asset value, then it’s perfectly acceptable for management to authorize a buyback.

Ellis disagreed with this view and tried to convince Schloss that book values weren’t a reliable way to value public companies. Below are some excerpts from the exchange, followed by the letters in full.

Walter Schloss: “I can understand the reluctance of management to repurchase its stock at, say, $30 share when the company’s stock has a $10 book value…however a company’s stock has a $100 book value, selling at $45 and earning $3 a share, with 2,000,000 shares outstanding. If the company repurchased 1,000,000shares at $50 a share, the book value for the remaining shares would increase to $150 a share, and the earnings would increase to close to $6 a share.”

Charles D. Ellis: “…I would agree that a company whose shares are selling below book value might find share repurchasing highly appropriate…however, I believe that an emphasis on book value is not appropriate for decision making in nonfinancial companies…while asset values are surely of primary importance in privately held firms, in publicly held companies the investors exercise no direct control over assets (cannot sell them, etc.) and must, therefore, concentrate on the profits which are generated from them.”

Walter Schloss: “I am not convinced by Mr. Ellis’ arguments that book value is unimportant in the repurchase policy of corporations except in the case of the repurchase of insurance and closed-end investment companies at a discount. While I realize that he places emphasis on earnings, it is also true that earnings are much more likely to fluctuate than are book values, and therefore estimating longer term earnings than, say, the next year or so can be subject to serious error…”