More often than not, value investors will start to buy a stock on the way down. The disappointments or reduced expectations that have made it cheap are not going away anytime soon, and here will still be owners of the stock who haven't yet given up when the value investor makes an initial puchase. If it is toward the end of the year, then selling to take advantage of tax losses can drive the price even more. Because they are aware that they are - to use the industry cliche - catching a falling knife, value investors are likely to try to scale into a position, buying it in stages.
- For some, such as Warren Buffett, that may not be so easy. Once the word is out that Berkshire Hathaway is a buyer, the stock shoots up in price.
- Graham himself, Walter Schloss recounts, confronted this problem. He divulged a name to a fellow investor over lunch; by the time he was back in the office, the price had risen so much that he could not buy more and still maintain his value discipline.
- This is one of the reasons why the Schlosses limit their conversations.
Still, when asked to name the mistake he makes most frequently, Edwin Schloss confesses to
- buying too much of the stock on the initial purchase and
- not leaving himself enough room to buy more when the price goes down.
- But the chances are against him.
- He often does get the opportunity to average down - that is, to buy additional shares at a lower price.
- The Schlosses have been in the business too long to think that the stock will now oblige them and only rise in price.
Value investors buy too soon and sell too soon, and the Schlosses are no exceptions.
- The cheap stocks generally get cheaper.
- When they recover and start to improve, they reach a point at which they are no longer bargains.
- The Schlosses start to sell them to investors who are delighted that the prices have gone up.
- In many instances, they will continue to rise, sometimes dramatically, while the value investor is searching for new bargains.
- The Schlosses bought the invetment bank Lehman Brothers a few years ago aat $15 a share, below book value. When it reached $35, they sold out. A few years later it had passed $130. Obviously that last $100 did not end up in the pockets of value investors.
- Over the years, they have had similar experiences with Longines-Wittnauer, Clark Oil, and other stocks that moved from undervalued through fair valued to overvalued without blinking.
- The money left on the table, to cite yet another investment cliche, makes for a good night's sleep.
The decision to sell a stock that has not recovered requires more judgement then does selling a winner. At some point, everyone throws in the towel.
- For value investors like the Schlosses, the trigger will generally be a deterioration in the assets or the earnings power beyond what they had initially anticipated.
- The stock may still be cheap, but the prospects of recovery have now started to fade.
- Even the most tolerant investor's patience can ultimately be exhausted.
- There are always other places to invest the money.
- Also, a realized loss has at least some tax benefits for the partners, whereas the depressed stock is just a reminder of a mistake.
Footnote:
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% per year.
For the nine and a half years that Walter Schloss worked for Ben Graham and for some years after he left to run his own partnership, he was able to find stocks selling for less than two thirds of working capital. But sometime after 1960, as the Depressin became a distant memory, those opportunites generally disappeared. Today, companies that meet that requirement are either so burdened by liabilities or are losing so much money that their future is in jeopardy. Instead of a margin of safety, there is an aura of doubt.
