Schloss 1995

Walter Schloss – April 1995
What makes these successful investors particularly interesting is that their good
fortune is not uniformly attributable to extraordinary brilliance--though they are certainly
smart--but more to the principles of value investing, which anyone with a solid grasp of
high school mathematics can learn. Value investors don't try to predict the growth
prospects of the latest high-tech darling. Instead they focus on stocks that are cheap by
basic measures such as market value to book value or earnings to price.
Take a closer look at the record of Walter Schloss, a walking, talking refutation of just
about every major tenet of the EMT and probably the purest example of a traditional
value investor. Schloss, 78, has been beating the S&P 500 since before there was an S&P
500. (Although data for the index now go back to 1926, S&P didn't create the 500 until
1957. Schloss began his market-beating run in 1955, and the following year outpaced
what would become the S&P 500.)
Over the 39 years that Schloss has been managing money on his own, the firm has
averaged an annual rate of return of slightly over 20%, while his limited partners have
made 15.5% a year on their money, reflecting the 25% cut of profits Schloss collects for
his services. Over the same period, the S&P 500 averaged a 10% return.
The high returns that Schloss has earned are possible in a world governed by the EMT,
but only if you take on much more risk than the market as a whole entails. Schloss,
however, has taken less risk. Consider: Since the Brooklyn Dodgers beat the Yankees in
the 1955 World Series, the S&P 500 has finished in the red nine times. Schloss lost
money in only six years, and eased the pain for his clients in those periods by forgoing
management fees. Says he: "I don't think I should get paid if I do a lousy job."
Described by someone who knows him well as "a man of modest talent and light work
habits," Schloss practices investing in a way that any ordinary investor can. Dressed in a
well-worn trader's smock, he works entirely from public documents and a few
publications like Value Line in one cramped, little office squirrelly with annual reports,
10-Ks, pictures of Babe Ruth, Lou Gehrig, and Schloss's children and grandchildren. The
one window looks out onto an air shaft. The total value of the fixed assets in that office?
Three thousand dollars. He has never had a computer or a fax machine, and he still pecks
away on an old Olympus manual typewriter to correspond with clients.
Schloss doesn't speak to the managements of the companies he invests in, because he
says he doesn't want to get attached to them. And he doesn't attend the companies' annual
meetings unless they are within a 20-block radius of his office. The simple truth here is
that Schloss holds no advantage over other investors. And he agrees: He claims to have
no special ability at analyzing businesses--a modest assertion with which his friends
generally agree.
Other investors may fly around the country searching for investment ideas; Schloss is far
more likely to spend the entire day chatting with his son Edwin, the only other member of
the firm, about the theater or the latest Updike novel, while their one telephone sits, un-
ringing, on Schloss's desk. What Schloss does have, however, says Chris Browne, of the
old-line investment firm Tweedy Browne, which has provided Schloss with office space
for many years, "is the ability to think for himself. Walter leans into the wind until the
wind changes."
Although Schloss says that he is flexible, he favors buying cheap companies as measured
by market to book value. He prefers looking at asset values rather than earnings because
he feels that accounting rules leave too much wiggle room to manipulate profits.
Generally he prefers to buy stocks that are selling for one-half to two-thirds of book
value. But they aren't easy to find--only about 15 members of the 1,600-stock Value Line
universe meet that criteria. So he will go up to 100% of book or even slightly over. He
gets in cheap, and when the stock price rises to what he thinks is fair, he gets out. Like
many other dyed-in-the-wool value investors, Schloss doesn't put a time limit on stocks
he buys. As long as the reasons for buying remain valid, he's willing to wait years for the
payoff.
Not all of Schloss's picks work out, but by maintaining a portfolio of about 75 to 100
stocks, which he turns over once every four years, he limits the damage from bad
decisions. And he has had a few of those, including Intertan, an electronics retailer that
Schloss bought in 1992, when the shares were $12. After Schloss invested, the stock
suffered a big drop as its earnings dried up. He sold last year at $8 a share. Says Schloss:
"We bought it at about half book value, but it just got worse." Even great value investors
occasionally have to admit they were wrong.
Schloss keeps his risk low in other ways: Because he gets in when prices are already low
and the market has low expectations for the company, he runs less chance of
disappointment than if he owned fast-growth stocks, where investor expectations run
high. Proof of Schloss's low-risk style came in a dramatic way in 1987. Going into that
fateful October, Schloss was up 53% for the first nine months, vs. 42% for the market.
But he finished the year up 26%, vs. the market's 5%.
There are no secrets to the way that Schloss invests. The value investing he practices can
be learned by anyone who takes the time. Just ask Schloss's landlord and fellow
outperformer, Tweedy Browne, which has passed on its successful value investing
strategy from one generation to the next like Grandma's recipe for pfefferneusen

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Walter Schloss – April 1995

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