Walter Schloss, ‘Superinvestor’ Who Earned Praise From Buffett, Dies at 95

By Laurence Arnold - Feb 21, 2012 9:22 AM GMT+0800

Enlarge image

Walter Schloss, right, stands for a photo with his son Edwin. Source: Heilbrunn Center for Graham and Dodd Investing, Columbia Business School via Bloomberg

Walter Schloss, the money manager who earned accolades from Warren Buffett (BRK/A) for the steady returns he achieved by applying lessons learned directly from the father of value investing,Benjamin Graham, has died. He was 95.

He died on Feb. 19 at his home in Manhattan, according to his son, Edwin. The cause was leukemia.

From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually on average after fees, compared with 10 percent for the Standard & Poor’s 500 Index. (SPX) His firm, Walter J. Schloss Associates, became a partnership, Walter & Edwin Schloss Associates, when his son joined him in 1973. Schloss retired in 2002.

Buffett, a Graham disciple whose stewardship of Berkshire Hathaway Inc. has made him one of the world’s richest men and most emulated investors, called Schloss a “superinvestor” in a 1984 speech at Columbia Business School. He again saluted Schloss as “one of the good guys of Wall Street” in his 2006 letter to Berkshire Hathaway shareholders.

“Walter Schloss was a very close friend for 61 years,” Buffett said yesterday in a statement. “He had an extraordinary investment record, but even more important, he set an example for integrity in investment management. Walter never made a dime off of his investors unless they themselves made significant money. He charged no fixed fee at all and merely shared in their profits. His fiduciary sense was every bit the equal of his investment skills.”

Began as ‘Runner’

To Buffett, Schloss’s record disproved the theory of an efficient market -- one that, at any given moment, assigns a reasonably accurate price to a stock. If companies weren’t routinely overvalued and undervalued, Buffett reasoned, long- term results like Schloss’s couldn’t be achieved, except through inside information.

Schloss, who never attended college, began working on Wall Street in 1935 as a securities-delivery “runner” at Carl M. Loeb & Co. He said Armand Erpf, the partner in charge of the statistical department, recommended that he read “Security Analysis” by Graham and David Dodd, published a year earlier. The book became a classic in the field. The firm then paid for Schloss to take two courses with Graham sponsored by the New York Stock Exchange Institute.

Schloss stayed in touch with Graham while serving four years in the U.S. Army during World War II, then went to work for Graham before striking out on his own.

The Schloss theory of investing, passed from father to son, involved minimal contact with analysts and company management and maximum scrutiny of financial statements, with particular attention to footnotes.

Focus on Statements

“The Schlosses would rather trust their own analysis and their longstanding commitment to buying cheap stocks,” Bruce Greenwald, Judd Kahn, Paul Sonkin and Michael van Biema wrote in “Value Investing: From Graham to Buffett and Beyond,” their 2001 book.

“This approach,” the authors wrote, “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.”

An example was copper company Asarco Inc. The Schlosses bought shares in 1999 as the stock bottomed out around $13. In November of that year, Grupo Mexico SA (GMEXICOB)bought Asarco for $2.25 billion in cash and assumed debt, paying almost $30 a share.

‘Guts to Buy’

“Basically we like to buy stocks which we feel are undervalued, and then we have to have the guts to buy more when they go down,” Schloss said at a 1998 conference sponsored by Grant’s Interest Rate Observer. “And that’s really the history of Ben Graham.”

Buffett, in his 2006 letter to shareholders, said Schloss took “no real risk, defined as permanent loss of capital” and invested “in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success.”

Edwin Schloss, now retired, said yesterday in an interview that his father’s investing philosophy and longevity were probably related.

“A lot of money managers today worry about quarterly comparisons in earnings,” he said. “They’re up biting their fingernails until 5 in the morning. My dad never worried about quarterly comparisons. He slept well.”

Walter Jerome Schloss was born on Aug. 28, 1916, in New York City, the son of Jerome H. Schloss and the former Evelyn Gomprecht, according to a paid notice in the New York Times. He attended the Franklin School in Manhattan, now part of the Dwight School.

Early Lessons

Schloss learned lessons about earning and saving from his father, whose radio factory warehouse burned down before a single unit was sold, and from his mother, who lost her family inheritance in the 1929 market crash, Alice Schroeder wrote in her 2009 book, “The Snowball: Warren Buffett and the Business of Life.”

He enlisted in the Army on Dec. 8, 1941, the day after Japan’s surprise attack on Pearl Harbor, and rose to the rank of second lieutenant. He served in Iran as part of the Signal Corps, then moved to the Pentagon in Washington to complete his tours of duty.

During this period, he stayed in touch with Graham, who was looking for a securities analyst just as Schloss was finishing up his wartime service. Schloss joined Graham-Newman in 1946.

Schloss first met Buffett at an annual meeting of wholesaler Marshall Wells, which drew both investors because it was trading at a discount to net working capital, according to a 2008 article in Forbes magazine. When Buffett joined Graham- Newman, he and Schloss shared an office.

While Buffett became a star inside the firm, Schloss was “pigeonholed as a journeyman employee who would never rise to partnership,” Schroeder, a Bloomberg News columnist, wrote in her book.

Schloss left Graham-Newman in 1955 and, with $100,000 from an initial 19 investors, began buying stocks on his own.

His wife, Louise, died in 2000. They also had a daughter, Stephanie. In 2001, Schloss married the former Ann Pearson.

http://www.bloomberg.com/news/2012-02-20/walter-schloss-superinvestor-who-earned-buffett-s-praise-dies-at-95.html

Walter Schloss -- What a Guy

Mon, 02/20/2012 - 17:03

Today brings the news that superinvestor and Buffett friend Walter Schloss is no longer with us.

I admired Walter for many reasons: his devotion to his family, his investing prowess, and his zest for life. His first wife was ill with serious depression for decades and throughout, he cared for her tirelessly. Meanwhile, he worked in a tiny closet-sized office at Tweedy Brown, and used essentially nothing but pencils, paper, and Value Line to produce some of the best investing results in history. Later his son Edwin joined him in the business, but they never deviated from the style that made him a success, which his friends referred to as mainly buying "buggy-whip manufacturers," moribund companies that were trading for less than their carcasses would be worth.

As for the zest, there is a photo in The Snowball of Walter dancing at his 90th birthday party. He was really cutting the rug, not just doing a pose for the camera, and you can tell how much fun he was having and what a lively person he was from that picture. That night he told me how much he enjoyed still being able to play tennis at his age. He had recently remarried and was fully involved in life.

The first time I ever spoke to Walter was several years earlier, in a phone interview. Warren had mentioned that Walter's political views were a "little more right wing" than Buffett's own. When we got on the phone, Walter immediately wanted let me know he just could not understand how Warren could believe the things he did about taxes. While Warren would always take his calls, Walter had found that if the subject turned to politics they tended to end quickly. So Walter figured that I was a possible vehicle to get his views through to Warren, and he made that very clear. My interview transcript ended up consisting about 75% of a message to Warren about his wrong-headedness on taxes. I must say that Warren took it well.

That was my introduction to the dynamic among the insiders in the Buffett Group. Walter was one of the earilier interviews, and as it turned out, only a prelude to a series of people who wanted to use part of their interviews to send the same message. But Walter was more outspoken than most. It seems appropriate that the news of his death would come on President's Day.

The most notable thing I remember about Walter, though, was not his politics; it was his generosity. It was he who helped me really understand what life was like working at Graham-Newman. He also contributed greatly to the portrait of Warren as a young investor. Walter gave me an abundance of information about Ben Graham, and later donated his papers to Columbia University. These are only examples, and I'm sure that many other people have stories of how open-hearted this man was. He will be very much missed.

http://www.aliceschroeder.com/blog/walter-schloss-what-guy

Seth Klarman's Baupost Group To Return Cash After Extraordinary Run -- Because He Can't Find Enough To Invest In

Henry Blodget | Nov. 10, 2010, 6:56 AM in

Seth Klarman

Seth Klarman's Baupost Group will return 5% of its capital to investors at the end of the year, says a source who has viewed a November 8th letter from Klarman to Baupost's investors.

Baupost has generated an monstrous $6.5 billion in net investment profits from January 1, 2009 to September 2010 ("net" of an estimated $2 billion of performance and management fees).

This growth has propelled the firm to an enormous $23 billion in assets. Klarman considers this size too large for the current market environment, in which he finds opportunities scarce.

"Today, Baupost's opportunity set is smaller than it has been in some years," Klarman wrote, "while our cash balances have grown..."

So Baupost's happy investors are getting 5% of their money back at the end of the year, whether they like it or not.

And other investors, who are just now getting bullish, might want to ask themselves what they're seeing that Klarman - and other hedge fund managers who are retiring for lack of opportunity (like Stanley Druckenmiller) - aren't.

Read more: http://www.businessinsider.com/seth-klarman-baupost-group-to-return-capital-2010-11#ixzz1n6OLqn3p

The Financial Life: Seth Klarman

June 17, 2010
The Financial Life: Seth Klarman
Making careful bets on a wide range of assets, he has a sterling record and manages more money than some better-known competitors

By Charles Stein

Some hedge fund managers are famous for big scores—John Paulson made $15 billion shorting the housing market. Then there's Seth Klarman, who got rich by making money steadily over time. As markets began to collapse in 2008, the founder of Baupost Group focused on corporate bonds he calculated would yield solid returns even if the economy got worse. "We didn't have the degree of conviction Paulson had," says Klarman, 53, in an interview in his Boston office. "We don't deal in absolutes. We deal in probabilities."

Baupost has returned 19 percent a year, net of fees, since Klarman started it in 1983, vs. 11 percent for the Standard & Poor's 500-stock index. His record helped Klarman almost double Baupost's assets, to $22 billion, over the past two years—a period when the hedge fund industry was seeing withdrawals. He runs more money than better-known managers such as Ken Griffin and Steven Cohen.

A value investor who looks for securities he considers underpriced, Klarman says he's best at "complicated" situations where fewer investors compete for assets. "He specializes in illiquid, complex assets," says Thomas Russo, a partner in investment firm Gardner Russo & Gardner who has known Klarman since 1984. Baupost has invested in Parisian office buildings, Russian oil companies, and real estate the U.S. government sold after the savings and loan crisis of the early 1990s, says Russo.

More recently, Klarman scored big buying the bonds of Washington Mutual and Ford Motor at deep discounts. When he can't find investments he likes, he's not afraid to sit on his hands, keeping as much as 40% of the fund in cash. Lately it has been 30%. If the firm can't come up with enough opportunities, it may return cash to investors, he says.

These days, less than 10% of Klarman's portfolio is in U.S. stocks. Except for a brief time in March 2009, he says, "stocks haven't been at bargain prices for most of the last two decades." Recently, he's been looking at privately held commercial real estate. While the fundamentals for much of that property are "terrible," he says, it may pay off for those willing to wait long enough.

After graduating from Cornell, Klarman worked for renowned value investor Michael Price; he later earned an MBA at Harvard. His views are so closely watched by investors that his out-of-print book, The Margin of Safety, published in 1991, is offered on Amazon.com (AMZN) for more than $1,700. Bruce Berkowitz, named Morningstar's (MORN) domestic stock manager of the decade, says Klarman stands out among fund managers because he's able to make money while holding cash and avoiding leverage. Says Berkowitz: "If he isn't Elvis, he's pretty close."

FUND
Baupost Group, with $22 billion under management

STRATEGY
Seeks undervalued, misunderstood assets

RECENT INVESTMENT INTEREST
Privately held commercial real estate

Stein is a reporter for Bloomberg News.

http://www.businessweek.com/print/magazine/content/10_26/b4184049326100.htm

You must think for yourself and not allow the market to direct you.

Be warned.  Do not confuse the real success of an investment with its mirror of success in the stock market .

• The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value. 
• Likewise, a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration.
• I t is vitally important for investors to distinguish stock price fluctuations from underlying business reality. 
• If the general tendency is for buying to beget more buying and selling to precipitate more selling, investors must fight the tendency to capitulate to market forces. 

You cannot ignore the market - ignoring a source of investment opportunities would obviously be a mistake -but you must think for yourself and not allow the market to direct you. 

• Value in relation to price, not price alone, must determine your investment decisions. 
• If you look to Mr. Market as a creator of investment opportunities (where price departs from underlying value), you have the makings of a value investor.  
• If you insist on looking to Mr. Market for investment guidance, however, you are probably best advised to hire someone else to manage your money.

Investors will frequently not know why security prices fluctuate. Must look beyond security prices to underlying business value.

Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception.

• The shares of many biotechnology companies doubled and tripled in the first months of 1991, for example despite a lack of change in company or industry fundamentals that could possibly have explained that magnitude of increase. 
• The only explanation for the price rise was that investors were suddenly willing to pay much more than before to buy the same thing.

In the short run supply and demand alone determine market prices. 

• If there are many large sellers and few buyers, prices fall, sometimes beyond reason. 
• Supply-and-demand imbalances can result from year-end tax selling, an institutional stampede out of a stock that just reported disappointing earnings, or an unpleasant rumor. 

Most day-to-day market price fluctuations result from supply- and-demand variations rather than from fundamental developments.


Investors will frequently not know why security prices fluctuate. 

• They may change because of, in the absence of, or in complete indifference to changes in underlying value. 
• In the short run investor perception may be as important as reality itself in determining security prices. 
• It is never clear which future events are anticipated by investors and thus already reflected in today's security prices. 

Because security prices can change for any number of reasons and because it is impossible to know what expectations are reflected in any given price level,  investors must look beyond security prices to underlying business value, always comparing the two as part of the investment process.


Main Point: 
Investors will frequently not know why security prices fluctuate and must look beyond security prices to underlying business value, always comparing the two as part of the investment process

Security Prices Move Up and Down for Two Basic Reasons: Business Reality or Supply and Demand

Security prices move up and down for two basic reasons:

• to reflect business reality (or investor perceptions of that reality) or 
• to reflect short-term variations in supply and demand. 

Reality can change in a number of ways,

• some company-specific, 
• others macroeconomic in nature. 

Company-specific factors

• If Coca-Cola's business expands or prospects improve and the stock price increases proportionally, the rise may simply reflect an increase in business value. 
• If Aetna's share price plunges when a hurricane causes billions of dollars in catastrophic losses, a decline in total market value approximately equal to the estimated losses may be appropriate. 
• When the shares of Fund American Companies , Inc., surge as a result of the unexpected announcement of the sale of its major subsidiary, Fireman's Fund Insurance Company, at a very high price, the price increase reflects the sudden and nearly complete realization of underlying value. 

On a macroeconomic level

These factors could each precipitate a general increase in security prices:

• a broad-based decline in interest rates, 
• a drop in corporate tax rates, or 
• a rise in the expected rate of economic growth.

Market Inefficiencies and Institutional Constraint: The Challenge of Finding Attractive Investments

The research task does not end with the discovery of an apparent bargain. It is incumbent on investors to try to find out why the bargain has become available.

• If in 1990 you were looking for an ordinary, four-bedroom colonial home on a quarter acre in the Boston suburbs, you should have been prepared to pay at least $300,000. 
• If you learned of one available for $150,000, your first reaction would not have been, "What a great bargain!" but,"What's wrong with it?"

The same healthy skepticism applies to the stock market. A bargain should be inspected and reinspected for possible flaws.

• Irrational or indifferent selling alone may have made it cheap, but there may be more fundamental reasons for the depressed price. 
• Perhaps there are contingent liabilities or pending litigation that you are unaware of. 
• Maybe a competitor is preparing to introduce a superior product.

When the reason for the undervaluation can be clearly identified, it becomes an even better investment because the outcome is more predictable. 

• By way of example, the legal constraint that prevents some institutional investors from purchasing low priced spin offs is one possible explanation for undervaluation. 
• Such reasons give investors some comfort that the price is not depressed for an undisclosed fundamental business reason.

Other institutional constrain can also create opportunities for value investors.

1.  For example, many institutional investors become major sellers of securities involved in risk-arbitrage transactions on the grounds that their mission is to invest in ongoing businesses, not speculate on takeovers. 

• The resultant selling pressure can depress prices, increasing the returns available to arbitrage investors.

2.  Institutional investors are commonly unwilling to to buy or hold low-priced securities. 

• Since any company can exercise a degree of control over its share price through splitting or reverse-splitting its outstanding shares, the financial rationale for this constraint is hard to understand. 
•  Why would a company's shares be a good buy at $15 a share but not at $3 after a five-for-one stock split or vice versa?

3.  Many attractive investment opportunities result from market inefficiencies, that is, areas of the security markets in which information is not fully disseminated or in which supply and demand are temporarily out of balance. 

• Almost no one on Wall Street, for example, follows, let a lone recommends, small companies whose shares are closely held and infrequently traded; there are at most a handful of market makers in such stocks.
• Depending on the number of shareholders, such companies may not even be required by the SEC to file quarterly or annual reports.  
• Obscurity and a very thin market can cause stocks to sell at pressed levels.

4.  Year-end tax selling also creates market inefficiencies.

• The International Revenue Code makes it attractive for investors to realize capital losses before the end of each year. 
• Selling driven by the calendar rather than by investment fundamentals frequently causes stocks that declined significantly during the year to decline still further. This generates opportunities for value investors.

Value Investing and Contrarian Thinking

Value investing by its very nature is contrarian.

• Out-of-favor securities may be undervalued, popular securities almost never are.  
• What the herd is buying is, by definition, in favor.  
• Securities in favor have already been bid up in price on the basis of optimistic expectations and are unlikely to represent good value that has been overlooked.

If value is not likely to exist in what the herd is buying, where may it exist?  In what they are selling, unaware of, or ignoring.  

• When the herd is selling a security, the market price may fall well beyond reason.  
• Ignored, obscure, or newly created securities may similarly be or become undervalued.  

Investors may find it difficult to act as contrarians for they can never be certain whether or when they will be proven correct.

• Since they are acting against the crowd, contrarians are almost always initially wrong and likely to suffer paper losses.  By contrast, members of the herd are nearly always right for a period.  
• Not only are contrarians initially wrong, they may be wrong more often and for longer periods than others because market trends can continue long past any limits warranted by underlying value.

Holding a contrary opinion is not always useful to investors, however.

• When widely held opinions have no influence on the issue at hand, nothing is gained by swimming against the tide.  It is always the consensus that the sun will rise tomorrow, but this view does not influence the outcome. 
• By contrast, when majority opinion does affect the outcome or the odds , contrary opinion can be put to use. 
• When the herd rushes into home health-care stocks, bidding up prices and thereby lowering available returns, the majority has altered the risk/reward ratio, allowing contrarians to bet against the crowd with the odds skewed in their favor. 
• When investors in 1983 either ignored or panned the stock of Nabisco, causing it to trade at a discount to other food companies, the risk/reward ratio became more favorable, creating a buying opportunity for contrarians.

Ref:  Margin of Safety by Seth Klarman

Warren Buffett - How to Be a Success

For the latest Warren Buffett, go to http://WarrenBuffettNews.com -

There will be a short speech in this MBA talk, and then there will be a question and answer session. It is important to think about your future. Everyone graduating has the ability to make a lot of money and to succeed. However in order to succeed, more is needed than intellect and energy. You also need integrity. Without integrity, intellect and energy doesn't matter too much.

Think for a moment that you had the right to buy 10% of one of your classmates for the rest of their lifetime. Are you going to give them an IQ test or pick the one with the best grades? Probably not. If you thought about this for an hour, you would probably invest in the person who has the type of leadership qualities, the type of person who has the ability to get other people to do what they want. By the same token, if you had to go short on one of your classmates, then you would also look for qualities like dishonesty and cutting corners.

As you reflect on those qualities, you will notice that they are all qualities that are achievable. They are not forbidden to other people. There aren't any negative qualities that you have to have. They are all simply habitual. Habits are too light to be felt until they are too heavy to cast off. When you are young, you can choose to have any habits that you want. Look around at the people that you admire and try to develop patterns of behavior like them. Benjamin Franklin did this and Benjamin Graham did it as well.

Warren Buffett is not a macro guy. But you can borrow money in Japan at 1%. You would think that you could make money if you can borrow money at 1%. However, he is having trouble finding anything. It is hard to make a lot as an investor if the business you are interested in doesn't make a large return on equity. However, you could take the cigar butt approach to investing. If you are looking for a free puff, then you can purchase a lousy business at a discount. Time is the friend of the wonderful business and the enemy of the lousy business. Japan had an incredible market without a lot of incredible businesses.

Warren Buffett - Coke vs McDonald's

For the latest Warren Buffett, go to http://WarrenBuffettNews.com -

There are a lot of things you can learn if you are around securities over the course of your career, and you will find a lot of arbitrage opportunities. However, that probably won't be the primary driver of your investment returns.

If you are not a professional investor, then you should be extremely diversified and you should do very little trading. However, if you want to bring an intensity to the game, and you are going to value businesses, then diversification is a terrible mistake. If you really know business, then you shouldn't own more than 6 businesses. Very few people have gotten rich on their 7th best idea. You'd be much better off putting more money into your best idea.

Proctor and Gamble is a good business. But if you are going to go away for 20 years, would you rather own Coca-Cola or Proctor and Gamble? Proctor and Gamble wouldn't be bad, but Coca-Cola has much better pricing power. They sell 1 billion units per day. If they charge a penny more, they will make another $10 million per day.

McDonald's has a lot of things going for it. But it is a tougher business. People do not want to eat at McDonald's every day. If someone drinks 5 Cokes today, they will probably buy 5 more tomorrow. The fast food business is tough, and they don't win taste tests. They are also competing on price more than they used to, and they give away toys in order to sell more product. It is better to own a business with a product that can stand alone absent promotions and price appeals. But it is a very good business. Not as good as Coca-Cola, but then again very few businesses are.

The utility industry is tough to understand because there are so many regulations. Obviously the guy who produces energy more cheaply has an advantage, but it is hard to predict how much of the profits he will be allowed to keep and whether he can sell his energy outside of his geographic area. A lot of money will be made in utilities, but it is hard to be able to tell who is going to make it.

Cash Hoard – Boon Or Bane For Shareholders

Imagine if you have S$100m in your bank account, what joys and problems would you face? I believe some of the joys would entail

• sacking your boss, 
• living it extravagantly 

but problems would include

• the deployment of cash, as well as, 
• fearing for your life if people are aware of your immense wealth.

If the above situation happens to companies with large cash holdings, the management would also face similar problems, especially on the issue of effective cash deployment.

So for companies with a large cash hoard, is it a boon or a bane? Let’s delve into the pros and cons of maintaining a substantial cash hoard.


Advantages

Reflective of a company with strong business performance

• One of the advantages is that a large cash hoard signals that the company seems to accumulate cash faster than it can deploy (assuming that the company is effectively deploying its cash but it is still accumulating).
• Furthermore, it is also reflective of a good business performance as cash is derived from profitable operations.

Buffer against bad times

• Cash can be used as a buffer against bad times or mistimed acquisitions. For example, during the recession in 2008/09, companies with large amounts of debt and little cash face refinancing difficulties and some even have problems paying off the loans when they are due. Ferrochina, ex Singapore listed firm in the manufacturing sector, is a case in point.
• Moreover, cash serves as a safety net against unpredictable events. Companies which carry out acquisitions, joint ventures, or maiden expansions into new markets or geographies are likely to face their fair share of failures and difficulties. Some business ventures may not reach their desired results and may run into temporary losses. Cash can be used to cover the losses in such situations.

Business facilitator

• Companies with cash holdings are also likely to be able to get favourable credit terms with suppliers and banks. 
• This is apparent as suppliers and banks have to access the credit risk of the companies which they are doing business with and companies with a considerable amount of cash holdings would allay part of their credit concerns. This would aid in the business operations of the companies.

Flexibility for future growth

• Cash also provides management with a myriad of options for future growth. For example, management can decide on the following options
• Look out for attractive acquisition targets either to expand horizontally or vertically along the value chain.
• Carry out capital expenditure such as to acquire land for future purpose, or expand their production capacity through buying more machines etc.
• Invest in listed companies purely for investment purposes.

Disadvantages



Dearth of attractive investment opportunities

• One of the most obvious reasons for a large cash hoard is that management has exhausted attractive investment opportunities at the moment and is keeping cash for future opportunities whenever that may be. 
• This does not benefit shareholders as holding substantial cash incurs an opportunity cost and also drag down the return generated by the companies. 
• Besides, shareholders prefer companies to return cash or carry out share buybacks if there are no attractive investment opportunities by the companies.

Lack of long term planning

• Some companies may not have the practice of planning for the long term. Thus, as they do not have a concrete idea of their cash requirements over the next three to five years, they would prefer to hold cash as this provide them with flexibility. 
• Nonetheless, it is generally non ideal to invest in companies which do not execute long term planning, as “failure to plan means planning to fail”.

Agency costs

• With substantial cash in the companies’ coffers, management may be tempted to use these funds to build their own empire by spending on non synergistic acquisitions and loss making projects, so as to boost their power, reputation and prestige.

Possibility of incurring suspicion and indignation from shareholders

• If the cash hoard is increasing and management does not have concrete plans on the use of such funds, this may incur the suspicion on the authenticity of actual cash owned by the companies. For example, Oriental Century, a Singapore listed firm in the education sector, has a large amount of cash in its books. However, it is subsequently revealed that its Chief Executive Officer has allegedly inflated the cash holdings.
• Another company, China Hongxing, a Singapore listed firm in the sports shoe and apparel sector, has been incurring the indignation of shareholders for more than a year by sitting on a large cash hoard, amounting to RMB3b at Dec 09, up from RMB1.9b at Dec 08. The collapse in its share price from the high of S$1.45 in Oct 07 to a low of S$0.055 in Mar 09 was due in part to investors’ angst and displeasure in China Hongxing management of cash. However, China Hongxing management has recently unveiled plans on how it would be deploying its cash.

Conclusion – evaluate against the overall context

To determine whether having a large cash hoard is beneficial to shareholders, shareholders have to evaluate against the following criteria:

• Companies’ existing and future incoming cash flows;
• Companies existing and future cash flow requirements (i.e. outflows);
• Stage of business cycles;
• Existing loan and interest repayments.

Thus, if the companies have concise plans to deploy their cash,

• either to satisfy outstanding loan repayments, 
• or for synergistic acquisition purposes, 
• or for capital expenditure in view of the recovery in the business cycles, 

then the cash hoard is a boon as it creates shareholder value.

Conversely, if management has

• no concrete plans to deploy the cash or 
• to deploy them in reckless fashion, 

then, the cash hoard is a bane as it destroys shareholder value.

Once again, investors have to put on their thinking hats and do some work to reach a decision on whether the cash hoard is a boon or a bane for shareholders.

Ernest Lim currently works as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore. He is currently taking a short break before embarking on a new role.



EDUCATION | 16 MARCH 2010
Cash Hoard – Boon Or Bane For Shareholders

By Ernest Lim

http://www.sharesinv.com/articles/2010/03/16/cash-hoard-boon-bane-sharesholders/

Reducing Portfolio Risk

The challenge of successfully managing an investment portfolio goes beyond making a series of good individual investment decisions. 

Portfolio management requires 

• paying attention to the portfolio as a whole, 
• taking into account diversification, 
• possible hedging strategies, and 
• the management of portfolio cash flow. 

In effect, while individual investment decisions should take risk into account, portfolio management is a further means of risk reduction for investors.

Appropriate Diversification

Even relatively safe investments entail some probability, however small, of downside risk.  The deleterious effects of such improbable events can best be mitigated through prudent diversification.



The number of securities that should be owned to reduce portfolio risk to an acceptable level is not great, as few as ten to fifteen different holdings usually suffice.



Diversification for its own sake is not sensible.

• This is the index fund mentality if you can't beat the market, be the market.  
• Advocates of extreme diversification - which I think of as over-diversification - live in fear of company-specific risks; their view is that if no single position is large, losses from unanticipated events cannot be great.  
• My view is that an investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings.  One's very best ideas are likely to generate higher returns from a given level of risk than one's hundredth or thousandth best idea.

Diversification is potentially a Trojan horse.

• Junk-bond-market experts have argued vociferously that a diversified portfolio of junk bonds carries little risk.  Investors who believed them substituted diversity for analysis and, what's worse, for judgment.  
• The fact is that a diverse portfolio of overpriced, subordinated securities, about each of which the investor knows relatively little,  is highly risky.  
• Diversification of junk-bond holdings among several industries did not protect investors from a broad economic downturn or credit contraction.  

Diversification, after all, is not how many different things you own, but how different the things you do own are in the risks they entail.

Hedging: It is not always smart to hedge.

Hedging

Market or systematic risk - the risk that the overall stock market could decline - cannot be reduced through diversification but can be limited by hedging.

An investor's choice among many possible hedging strategies depends on the nature of his or her underlying holdings.

• A diversified portfolio of large capitalization stocks, for example, could be effectively hedged through the sale of an appropriate quantity of Standard & Poor's 500 index futures.  This strategy would effectively eliminate both profits and losses due to broad-based stock market fluctuations.  If a portfolio were hedged through the sale of index futures, investment success would thereafter depend on the performance of one's holdings compared with the market as a whole.
• A portfolio of interest-rate-sensitive stocks could be hedged by selling interest rate futures or purchasing or selling appropriate interest rate options.  
• A gold-mining stock portfolio could be hedged against fluctuations in the price of gold by selling gold futures.
• A portfolio of import- or export-sensitive stocks could be partially hedged through appropriate transactions in the foreign exchange markets.  

It is not always smart to hedge.

• When the available return is sufficient, for example, investors should be willing to incur risk and remain unhedged.  
• Hedges can be expensive to buy and time-consuming to maintain, and overpaying for a hedge is as poor an idea as overpaying for an investment.  
• When the cost is reasonable, however, a hedging strategy may allow investors to take advantage of an opportunity that otherwise would be excessively risky.  

In the best of all worlds, an investment that has valuable hedging properties may also be an attractive investment on its own merits.

The best investment opportunities arise when other investors act unwisely

There is nothing inherent in a security or business that alone makes it an attractive investment.  Investment opportunity is a function of price, which is established in the marketplace.

• Whereas some investors are company- or concept-driven, anxious to invest in a particular industry, technology, or fad without special concern for price, a value investor is purposefully driven by price.  
• A value investor does not get up in the morning knowing his or her buy and sell orders for the day, these will be determined in the context of the prevailing prices and an ongoing assessment of underlying values.  

Since transacting at the right price is critical, trading is central to value - investment success.

• This does not mean that trading in and of itself is important, trading for its own sake is at best a distraction and at worst a costly digression from an intelligent and disciplined investment program.  
• Investors must recognize that while over the long run investing is generally a positive sum activity, on a day-to-day basis most transactions have zero sum consequences.  
• If a buyer receives a bargain, it is because the seller sold for too low a price.  If a buyer overpays for security, the beneficiary is the seller, who received a price greater than underlying business value.  

The best investment opportunities arise when other investors act unwisely thereby creating rewards for those who act intelligently.

• When others are willing to overpay for a security, they allow value investors to sell at premium prices or sell short at overvalued levels.  
• When others panic and sell at prices far below underlying business value, they create buying opportunities for value investors.  
• When their actions are dictated by arbitrary rules or constraints, they will overlook outstanding opportunities or perhaps inadvertently create some for others.  
• Trading is the process of taking advantage of such mispricings.

Stay in Touch wi th the Market

Some investors buy and hold for the long term, stashing their securities in the proverbial vault for years.  While such a strategy may have made sense at some time in the past, it seems misguided today.  

• This is because the financial markets are prolific creators of investment opportunities.  
• Investors who are out of touch with the markets will find it difficult to be in touch with buying and selling opportunities regularly created by the markets.  
• Today with so many market participants having little or no fundamental knowledge of the businesses their investments represent, opportunities to buy and sell seem to present themselves at a rapid pace.  
• Given the geopolitical and macroeconomic uncertainties we face in the early 1990s and are likely to continue to face in the future, why would abstaining from trading be better than periodically reviewing one's holdings?

Being in touch with the market does pose dangers, however.

• Investors can become obsessed, for example, with every market uptick and downtick and eventually succumb to short-term-oriented trading.  
• There is a tendency to be swayed by recent market action, going with the herd rather than against it.  

Investors unable to resist such impulses should probably not stay in close touch with the market, they would be well advised to turn their investable assets over to a financial professional.

Another hazard of proximity to the market is exposure to stockbrokers.

• Brokers can be a source of market information, trading ideas, and even useful investment research.  
• Many, however, are in business primarily for the next trade.  

Investors may choose to listen to the advice of brokers but should certainly confirm everything that they say.  Never base a portfolio decision solely on a broker's advice, and always feel free to say no.

Buying: Leave Room to Average Down

The single most crucial factor in trading is developing the appropriate reaction to price fluctuations.  Investors must learn to resist:

• fear, the tendency to panic when prices are falling, and 
• greed, the tendency to become overly enthusiastic when prices are rising.  

One half of trading involves learning how to buy.

• In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once.  
• Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve.  
• Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline.  

Evaluating your own willingness to average down can help you distinguish prospective investments from speculations.  

• If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices.  
• If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place.  
• Potential investments in companies that are poorly managed, highly leveraged, in unattractive businesses, or beyond understanding may be identified and rejected.

The Value Investor's Handbook

March 20 2011 

Value investing, and any type of investing for that matter, varies in execution with each person. There are, however, some general principles that are shared by all value investors. These principles have been spelled out by famed investors like Peter Lynch, Kenneth Fisher, Warren Buffet, John Templeton and many others. In this article, we will look at these principles in the form of a value investor's handbook.

Tutorial: The World's Greatest Investors

Buy BusinessesIf there is one thing that all value investors can agree on, it's that investors should buy businesses, not stocks. This means ignoring trends in stock prices and other market noise. Instead, investors should look at the fundamentals of the company that the stock represents. Investors can make money following trending stocks, but it involves a lot more activity than value investing. Searching for good businesses selling at a good price based on probable future performance requires a larger time commitment for research, but the payoffs include less time spent buying and selling and fewer commission payments. (False signals can drown out underlying trends. Find out how to tone them down and tune them out in Trading Without Noise.)

Love the Business You BuyYou wouldn't pick a spouse based solely on his or her shoes, and you shouldn't pick a stock based on cursory research. You have to love the business you are buying, and that means being passionate about knowing everything about that company. You need to strip the attractive covering from a company's financials and get down to the naked truth. Many companies look far better when you judge them on basic price to earnings (P/E), price to book (P/B) and earnings per share (EPS) ratios than they do when you look into the quality of the numbers that make up those figures.

If you keep your standards high and make sure the company's financials look as good naked as they do dressed up, you're much more likely to keep it in your portfolio for a long time. If things change, you'll notice it early. If you like the business you buy, paying attention to its ongoing trials and successes becomes more of a hobby than a chore.

Simple Is BestIf you don't understand what a company does or how, then you probably shouldn't be buying shares. Critics of value investing like to focus on this main limitation. You are stuck looking for businesses that you can easily understand because you have to be able to make an educated guess about the future earnings of the business. The more complex a business is, the more uncertain your projections will necessarily be. This moves the emphasis from "educated" to "guess."

You can buy businesses you like but don't completely understand, but you have to factor in uncertainty as added risk. Any time a value investor has to factor in more risk, he has to look for a larger margin of safety - that is, more of a discount from the calculated true value of the company. There can be no margin of safety if the company is already trading at many multiples of its earnings, which is a strong sign that, however exciting and new the idea is, the business is not a value play. Simple businesses also have an advantage, as it's harder for incompetent management to hurt the company. (For a complete guide to reading the financial reports, check out our Financial Statements Tutorial.)

Look for Owners, Not ManagersManagement can make a huge difference in a company. Good management adds value beyond a company's hard assets. Bad management can destroy even the most solid financials. There have been investors who have based their entire investing strategies on finding managers that are honest and able. To quote Buffett, "look for three qualities: integrity, intelligence, and energy. And if they don't have the first, the other two will kill you." You can get a sense of management's honesty through reading several years' worth of financials. How well did they deliver on past promises? If they failed, did they take responsibility, or gloss it over? (Find out more about Buffett's investing in Warren Buffett: How He Does It.)

Value investors want managers who act like owners. The best managers ignore the market value of the company and focus on growing the business, thus creating long-term shareholder value. Managers who act like employees often focus on short-term earnings in order to secure a bonus or other performance perk, sometimes to the long-term detriment of the company. Again, there are many ways to judge this, but the size and reporting of compensation is often a dead give away. If you're thinking like an owner, you pay yourself a reasonable wage and depend on gains in your stock holdings for a bonus. At the very least, you want a company that expenses its stock options. (Still wondering how to investigate the top brass? Check out Evaluating A Company's Management.)

When You Find a Good Thing, Buy a LotOne of the areas where value investing runs contrary to commonly accepted investing principles is on the issue of diversification. There are long stretches where a value investor will be idle. This is because of the exacting standards of value investing as well as overall market forces. Toward the end of a bull market, everything gets expensive, even the dogs, so a value investor may have to sit on the sidelines waiting for the inevitable correction. Time, an important factor in compounding, is lost while waiting, so when you do find undervalued stocks, you should buy as much as you can. Be warned, this will lead to a portfolio that is high-risk according to traditional measures like beta. Investors are encouraged to avoid concentrating on only a few stocks, but value investors generally feel that they can only keep proper track of a few stocks at a time.

One obvious exception is Peter Lynch, who kept almost all of his funds in stocks at all times. Lynch broke stocks into categories and then cycled his funds through companies in each category. He also spent upwards of 12 hours every day checking and rechecking the many stocks held by his fund. As an individual value investor with a different day job, however, it's better to go with a few stocks for which you've done the homework and feel good about holding long term. (Learn the basic tenets that helped this famous investor earn his fortune in Pick Stocks Like Peter Lynch.)

Measure Against Your Best InvestmentAnytime you have more investment capital, your aim for investing should not be diversity, but finding an investment that is better than the ones you already own. If the opportunities don't beat what you already have in your portfolio, you may as well buy more of the companies you know and love, or simply wait for better times. During idle times, a value investor can identify the stocks he or she wants and the price at which they'll be worth buying. By keeping a wish list like this, you'll be able to make decisions quickly in a correction.

Ignore the Market 99% of the TimeThe market only matters when you enter or exit a position; the rest of the time, it should be ignored. If you approach buying stocks like buying a business, you'll want to hold onto them as long as the fundamentals are strong. During the time you hold an investment, there will be spots where you could sell for a large profit and others were you're holding an unrealized loss. This is the nature of market volatility.

The reasons for selling a stock are numerous, but a value investor should be as slow to sell as he or she is to buy. When you sell an investment, you expose your portfolio to capital gains and usually have to sell a loser to balance it out. Both of these sales come with transaction costs that make the loss deeper and the gain smaller. By holding investments with unrealized gains for a long time, you forestall capital gains on your portfolio. The longer you avoid capital gains and transaction costs, the more you benefit from compounding. (Find out how your profits are taxed and what to consider when making investment decisions in Tax Effects On Capital Gains.)

The Bottom LineValue investing is a strange mix of common sense and contrarian thinking. While most investors can agree that a detailed examination of a company is important, the idea of sitting out on a bull market goes against the grain. It's undeniable that funds held constantly in the market have outperformed cash held outside the market, waiting for a down market. This is a fact, but a deceiving one. The data is derived from following the performance of indexes like the S&P 500 over a number of years. This is where passive investing and value investing get confused.


In both types of investing, the investor avoids unnecessary trading and has a long-term holding period. The difference is that passive investing relies on average returns from an index fund or other diversified instrument. A value investor seeks out above-average companies and invests in them. Therefore, the probable range of return for value investing is much higher. In other words, if you want the average performance of the market, you're better off buying an index fund right now and piling money into it over time. If you want to outperform the market, however, you need a concentrated portfolio of outstanding companies. When you find them, the superior compounding will make up for the time you spent waiting in a cash position. Value investing demands a lot of discipline on the part of the investor, but in return offers a large potential payoff. (Looking for a little more information on index investing, see the Index Investing Tutorial.)

by

Andrew Beattie

Read more: http://www.investopedia.com/articles/fundamental-analysis/09/value-investing.asp?partner=basics021710#ixzz1mjpmDWOA

Selling: The Hardest Decision of All

Many investors are able to spot a bargain but have a harder time knowing when to sell.  

• One reason is the difficulty of knowing precisely what an investment is worth.  
• An investor buys with a range of value in mind at a price that provides a considerable margin of safety.  
• As the market price appreciates, however, that safety margin decreases; the potential return diminishes and the downside risk increases.  
• Not knowing the exact value of the investment, it is understandable that an investor cannot be as confident in the sell decision as he or she was in the purchase decision.

To deal with the difficulty of knowing when to sell, some investors create rules for selling based on 

• specific price-to-book value or price-to-earnings multiples.  
• Others have rules based on percentage gain thresholds; once they have made X percent, they sell.  
• Still others set sale price targets at the time of purchase, as if nothing that took place in the interim could influence the decision to sell.  

None of these rules makes good sense.  Indeed, there is only one valid rule for selling:  all investments are for sale at the right price.

Decisions to sell, like decisions to buy, must be based upon underlying business value.  Exactly when to sell or buy depends on the alternative opportunities that are available.

Should you hold for partial or complete value realization, for example?

• It would be foolish to hold out for an extra fraction of a point of gain in a stock selling just below underlying value when the market offers many bargains.  
• By contrast, you would not want to sell a stock at a gain (and pay taxes on it) if it were still significantly undervalued and if there were no better bargains available.

Some investors place stop-loss orders to sell securities at specific prices, usually marginally below their cost.

• If prices rise, the orders are not executed. 
• If the prices decline a bit, presumably on the way to a steeper fall, the stop-loss orders are executed. 

Although this strategy may seem an effective way to limit downside risk, it is, in fact, crazy.  Instead of taking advantage of market dips to increase one's holdings, a user of this technique acts as if the market knows the merits of a particular investment better than he or she does.

Liquidity considerations are also important in the decision to sell.

• For many securities the depth of the market as well as the quoted price is an important consideration.  
• You cannot sell, after all, in the absence of a willing buyer, the likely presence of a buyer must therefore be a factor in the decision to sell.  
• As the president of a small firm specializing in trading illiquid over the counter stocks once told me:  "You have to feed the birdies when they are hungry."

If selling still seems difficult for investors who follow a value-investment philosophy, I offer the following rhetorical questions:  

• If you haven't bought based upon underlying value, how do you decide when to sell?  
• If you are speculating in securities trading above underlying value, when do you take a profit or cut losses?  
• Do you have any guide other than "how they are acting," which is really no guide at all?

Adopt a Value-Investing Philosophy and Start Investing Today

Once you choose to venture beyond U.S. Treasury bills, whatever you do with your money carries some risk. 

Don't think you can avoid making a choice; inertia is also a decision.

It took a long time to accumulate whatever wealth you have; your financial well-being is definitely not some thing to trifle with.

For this reason, I recommend that you adopt a value-investing philosophy and either

• find an investment professional with a record of value-investment success or 
• commit the requisite time and attention to investing on your own.

There are a number of issues that investors should consider in managing their portfolio.

While individual personalities and goals can influence one's trading and portfolio management techniques to some degree, sound buying, and selling strategies, appropriate diversification, and prudent hedging are of importance to all investors.

Of course, good portfolio management and trading are of no use when pursuing an inappropriate investment philosophy, they are of maximum value when employed in conjunction with a value investment approach.

Ref:  Margin of Safety by Seth Klarman