In Value Investing: From Graham to Buffett and Beyond, written by Bruce Greenwald, Judd Kahn, Pauld D. Sonkin and Michael van Biema, the authors devote chapter 15 to Walter and Edwin Schloss in the third part of the book entitled Value Investing in Practice: Profiles of Eight Value Investors. Below is the first part of an excerpt of this chapter.
Walter and Edwin Schloss: Keep It Simple, and Cheap
Walter Schloss started his partnership in the middle of 1955. He tracks his performance from January 1, 1956, a date sufficiently historic to give him one of the longest uniterrupted records―same manager, same organization―in investment history. He also has one of the best. Over the entire 45-year period from 1956 through 2000, Schloss and his son Edwin, who joined him in 1973, have provided their investors a compounded return of 15.3 percent per year. During the same period, the Standard and Poor’s Industrial Index [1] had comparable total return of 11.5 percent. Every dollar a fortunate investor entrusted with Schloss at the start of 1956 had grown to $662 by the end of 2000, including all charges for management (see figure 15.1). A dollar invested in the S&P Index would have been worth $118. The Schlosses’ accomplishment is even better than this initial comparison suggests. Over that entire 45-year period, their portfolio had seven years in wich it lost money; the S&P Index had 11. The average loss in the Schloss partnership was 7.6 percent; in the S&P, 10.6 percent. Modern investment theory argues that return is compensation for risk, that higher returns are achieved only by increasing the volatility of the portfolio. The investment success of the Schlosses does not confirm the theory.
Walter and Edwin Schloss are minimalists. Their office―Castle Schloss has one room―is spare; they don’t visit companies; they rarely speak to management; they don’t speak to analysts; and they don’t use the Internet. Not wanting to be swayed to do something they shouldn’t, they limit their conversations. There is an abundance of articulate and intelligent people in the investment world, most of whom can cite persuasive reasons for buying this stock or that bond. The Schlosses would rather trust their own analysis and their long-standing commitment to buying cheap stocks. This approach leads them to focus almost exclusively on the published financial statements that public firms must produce each quarter. They start by looking at the balance sheet. Can they buy the company for less than the value of the assets, net of all debt? If so, the stock is a candidate for purchase.
This may sound familiar. If Walter Schloss was not present at the creation of value investing, he showed up shortly thereafter. He started on Wall Street in 1934, at age 18, in the midst of the Depression. During the late 1930s, Schloss took courses from Benjamin Graham at the New York Stock Exchange Institute. He was in good company; his fellow students included Gus Levy, head of the arbitrage department at Goldman Sachs; Cy Winters of Abfraham, at one time president of the New York Society of Security Analysts; and other Wall Street heavyweights. At the time Schloss was working at Carl M. Loeb and Company, Graham’s brother Leon was a customer’s man at the firm, and Graham kept his account there, allowing Schloss to confirm that Graham did indeed practice what he preached in class. And he preached value―the advantage of paying less for stocks than for the value of the current assets after deducting all liabilities. Graham hired Schloss in 1946, as soon as Walter was discharged from the service.
One of Graham’s favorite teaching strategies was to analyze two companies side by side, even if they were in different industries, and compare the balance sheet. He would take Coca-Cola and Colgate, related to one another only by alphabetical proximity, and ask which stock was more of a bargain relative to the net asset values. Graham’s primary concern was the margin of safety, a focus which prevented him from recognizing the great growth potential in Coke. Not all of Graham’s tactics worked out. He would buy a leading company in an industry, such as the Illinois Central Railroad, and sell short a secondary one, like Missouri Kansas Texas, as a hedge. As it turned out, the two securities were not correlated, and the hedge did not work out. Another type of hedge that Graham used repeatedly was to buy a convertibel preferred stock and short the common. If the common rose, he was protected by the convertible future. If it fell, he made money on the short. In either case, he collected the dividend. This approach has become a standard practice in the industry even though it no longer has the tax advantage it once did. Schloss sees Graham as a legitimate genius, someone whose thinking was original and often contrary to established wisdom. Graham’s motivation, Schloss thinks, was primary intellectual. He was more interested in the ideas than in the money, although that too had its rewards.
[1] Walter Schloss began using the S&P Industrial in 1955 because without utilities or transportation companies, it more accurately matched the investments in his portfolio. He has kept that index as his benchmark comparison even as the S&P 500 has become the proxy of choice. Comparing the two over the last two decades, we found that they tracked each other very closely and that the Industrial had a slightly higher return than the 500.
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.
