Inside a cramped office on East 42nd Street in New York City in 1954, three men sifted through financial statements, jotting down numbers furiously. They were looking for opportunities the rest of the market had passed over. They were looking for companies that had fallen out of favor. They were looking for stocks that had been cast into the bargain bin.
The oldest, Benjamin Graham, was already an investing legend. He founded the firm Graham-Newman in 1926. By 1934, he was regarded as the godfather of value investing, having published the book Security Analysis, which is still considered to be the value investor's bible. He followed up with the equally famous book, The Intelligent Investor, in 1949.
The youngest of the three was Warren Buffett, who would go on to become the world's greatest investor. Buffett joined Graham-Newman in 1954 and worked there until 1956, when he decided to leave New York and return to Omaha to start Buffett Associates, Ltd.
The third man, recently returned from serving in the Army during World War II, was Walter Schloss. Schloss and Buffett shared an office during the time they overlapped at Graham-Newman and they developed a great fondness for each other, which continues to this day.
If you happen to value Warren Buffett's opinion, then Walter Schloss may be the greatest investor you've never heard of.
Onward and Upward
In 1955, Schloss left Graham-Newman with 19 clients and $100,000. He started an investment partnership and promptly aligned his interests with those of his clients -- he was compensated with 25% of any profits, but in the event of losses, his investors had to get back to even before Schloss made a penny. He never marketed or promoted his fund, but even so, Schloss's fund continued growing by word of mouth.
Since he was on his own, he had the freedom to run his business however he pleased. He generally worked from 9:30 in the morning to 4:30 in the afternoon. In 1973, he hired the one and only analyst he would ever need -- his son, Edwin. He never owned a computer. He gathered information from newspapers and company reports sent to him by mail. He scoured hand-me-down issues of Value Line that Edwin brought him, refusing to ever pay for his own subscription.
On April 15, 1994, Schloss's old friend, Warren Buffett, touted Schloss in a letter to investors. Buffett wrote:
"Please note that Walter's total office expense is about $11,000 as compared to net income of $19 million.
Meanwhile, Walter continues to outperform managers who work in temples filled with paintings, staff and computers. And he accomplishes this feat by rummaging among the cigar butts on the floor of capitalism."
By today's standards (and even by yesterday's standards) Schloss seemed to be working with one hand tied behind his back. But his eccentricities masked a simple idea: In order to beat the market, devise a good plan and stick to it.
Method + Discipline
Schloss has stuck to a few basic principles that have guided him throughout his career: Know what you want to do, know your strengths and weaknesses, don't kid yourself, enjoy your work and have high ethical standards.
First and foremost, Schloss has always loved value investing. At 94 years old, he still actively manages his own multi-million dollar portfolio from his New York City apartment.
He's also always known his strengths and weakness. To emphasis the former and mitigate the latter, he devised a method and never wavered from it. He looks for firms that trade at a discount to book value, with little or no debt, and with management that owns a high percentage of company stock, which align their goals with those of shareholders. Furthermore, he still references his 1934 first edition of Security Analysis, which is now held together with scotch tape.
Unlike Buffett, he doesn't care to understand every little thing about a company's operations. His portfolio will hold up to 100 stocks at a time as a hedge against the unknowns he doesn't spend time researching. Even so, Buffett has constantly praised his former colleague, calling him a "superinvestor" and a flesh-and-blood refutation of efficient markets theories, which assert the markets always have stocks priced accurately.
From 1955 to 2000, Schloss achieved +15.7% returns for his investors (after fees). The S&P returned +11.2% over the same period.
One day in 2001, Edwin realized that he couldn't find any cheap stocks. So in sticking with the method that had served them well for over fifty years, he and his father did something remarkable: They closed up shop and returned all of the fund's money to its investors. A fitting end for the fund manager who touted method, discipline, and high ethical standards.
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