Value investing can be divided into two separate groups. One side focuses upon the sustainability of earnings and the efficiency in which the earnings are reinvested, while the other side focuses upon the value of the assets. Walter Schloss is a proponent of the latter camp.

Mr. Schloss started his own investment partnership after leaving Graham-Newman in 1955. The partnership was started with a modest sum of $100,000 which he raised from a small group of investors, including himself. By the end of 1984, Schloss and his son were managing approximately 45 million in assets. In 28 years, Schloss had earned his investors a compounded annual rate of 16.1% (after taking out 25% fees) vs. a compounded rate of 8.4% for the S&P which included dividends. The intent of this article is to provide an in depth description of the investment philosophy which allowed Schloss to dramatically outperform the major indices over many decades.

Assets are Safer than Earnings

Schloss believed that investors should attempt to limit their downside when investing. He felt the best way to accomplish this was to focus on the assets of a company rather than their earnings. The following quotes are from his letter on Factors Needed to Make Money in the Market: “Earnings can change dramatically. Usually assets change slowly.” “One has to know more about a company if one buys earnings”.

In my experience, the concept that assets outweigh earnings is an extremely contrarian investment viewpoint. Most investors focus on earnings and many are simply unable to purchase shares of a company which is currently losing money. Schloss felt that purchasing discounted assets provided a substantial margin of safety for investors; a notion that he learned from Benjamin Graham. He felt the value of the assets would eventually be recognized if any of the following conditions occurred: the earnings cycle turned, the assets were liquidated and distributed to shareholders, the company was bought out or the management decided to take the company private.

Schloss on the dangers of focusing on earnings for the ordinary investor from the 1985 Barron’s interview: “Most look at earnings and earnings potential, well I can’t get into that game. This is a little outfit here, to try to compete with big brokerage house analysts, with all their connections and all their information”.

If we analyze the 28 year results from 1956 to 1984 provided by the Barron’s interview, it appears than Schloss’s stategy is validated. During that period, the small group of investors which put their faith and bankrolls into Schloss’s fund, not only outperformed the S&P by nearly 8% per year on an annualized basis, they also experienced only six years where the S&P plus dividends outperformed Schloss on a year by year basis. It seems that the Schloss method not only reduces risk, it also provides outstanding returns! View: The Right Stuff – Why Walter Schloss is Such a Great Investor

Passive Investment Style

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