Buffett vs Munger vs Schloss and Thoughts on Portfolio Strategy

Posted on Posted in How to Improve Results, Investment Philosophy, Portfolio Management, Superinvestors, Think Differently, Walter Schloss, Warren Buffett

I was having a conversation about Munger’s philosophy vs Schloss’ philosophy and had a few thoughts (and below I’ll compare their performance results against Buffett’s)…

I often like to look at long term past performance of investors (10 years or longer) to draw conclusions about the effectiveness of their investment approach. I’ve often discussed on this site the many value investors out there with average returns.

I used to ask myself ‘how can their returns be average when they clearly are smart people who understand business and value investing principles?

In most cases, I’ve concluded that their average results are not because they don’t understand effective investment principles, but it’s because they are not willing to implement an investment policy that goes against the consensus opinion of the majority.

I’ve mentioned before that one of the things that can benefit an investor who is looking for above average long term results is to study a select few investors who have made 20-30% annual returns over long periods of time. They will most likely be value investors, and they all mostly share the same principles, but if you really dig into how they managed their portfolios, you’ll notice two key differences in most cases:

  1. They were either very diversified but owned a lot of Graham type stocks at very low prices relative to earnings/assets, or
  2. They were very concentrated and owned just a few select outstanding businesses

Usually it’s one method or the other, but not both.

  • Lampert made 30% for the better part of 2 decades but usually had fewer than 10 stocks.
  • Pabrai has averaged 25% for almost 20 years now, but typically owns 10 stocks or less, etc…

On the other hand…

Following either of the two methods is mentally difficult for most people to implement. Following and sticking to Graham stocks is tough. They often are cheap, but they often have mediocre businesses attached to them. They often have problems, and thus the reason they are offered to you cheaply. On the other hand, it’s great to own great businesses, but it’s mentally difficult to concentrate your portfolio on the best ideas. Far easier to diversify…

Combining Strategies Dilutes Performance

My conclusion after studying countless other investors’ portfolio holdings and their results is that most investors (even most value fund managers) will end up combining aspects of number 1 with aspects of number 2.

In other words, they end up using diversification (like Graham and Schloss) and combining it with owning great businesses (like Munger and Buffett). This leaves them with too many stocks at mediocre prices. It’s just the way the market works…. great businesses rarely go on sale. Occasionally they do, but not often enough to own 30 or 40 of them at once. This type of portfolio management will just will lead to overpaying for good merchandise, and thus lowering your overall portfolio returns.

If you want to diversify, you have to own the cheapest stocks in the market, and those typically aren’t easy to own. If you want the best businesses, you have to really focus on the best businesses (for an extreme example of the latter, check out Allan Mecham’s latest 13-f). Both can work, but too many investors end up sacrificing valuation in the name of quality.

So it’s important to “Think Differently”. Invert, always invert.

Buffett vs Munger vs Schloss Record

I thought it would be fun to display the results of three of the greatest of all time. Munger was a franchise, high ROC type investor. Schloss was exactly the opposite. He owned cheap stocks. Buffett had elements of both, and it was around this time that he was transitioning from the latter to the former…

Here are the three head to head during the time they were all running outside capital (Buffett’s results are his partnership results until 1969, and the book value growth of Berkshire thereafter). This is like Ruth vs Aaron vs Williams…

Buffett vs Munger vs Schloss

Note: These are gross returns before fees… I wanted to display the effectiveness of the strategy before accounting for various fee structures that the three investors had. But both gross and net returns vastly outperformed the market.

So Buffett won this three way battle from 1962-1975. Munger retired his partnership after 1975. And despite Walter Schloss coming in third place during the above period (although still crushing the Dow), it’s worth noting that Schloss went on the best streak of his career from 1975-1983, averaging in excess of 30% per year during that time period.

Suffice it to say that each investor had his own style, but they had one thing in common… they all did things far differently than the crowd, and thus achieved results that were far different than the crowd. 

 

34 thoughts on “Buffett vs Munger vs Schloss and Thoughts on Portfolio Strategy

  1. Phenomenal post.

    “…too many investors end up sacrificing valuation in the name of quality.”

    Howards Marks was right when he said investors should remove the word quality from their vocabulary.

    Excellent blog by the way.

    Hugo

  2. Hi John,

    In economics it is impossible to validate a theory empirically because the subjects being analyzed have free will and can not be “controlled” in the way you’d need to to establish cause-effect empirically. As a result, economic law must be discovered and validated through logical deduction.

    I have often wondered about this with investment theory as well. I have never accepted things like technical analysis, etc., because they don’t work out logically. But “value investing” seems to be logically coherent and systematic. Its principles are universal (across asset markets and time periods)– even when they “don’t work” because markets are overpriced relative to value, they are actually working because that’s the whole premise– if you pay too much for something, you take a risk of diminishing your return or even making it negative. It’s such a simple principle, almost obvious.

    The various studies of people’s returns with various strategies, including value strategies, are interesting and inspiring. The Tweedy Browne assessment, as well as the long-term records of Buffett and others (assuming it can be attributed to “value investing” and not float-massaging or options/derivatives speculation, etc.), all give value investors confidence. I think BECAUSE value investing is logically valid it shouldn’t surprise us if the most able practitioners have also had successful empirical records.

    But I am not convinced that the records themselves speak to the merits of the approach. The reason is that there are so many specific, historical contexts and factors at play that it’s hard to say whether the result in any given period, (ie, “15%/yr for 25 years!) is a result of “value investing” or those other factors.

    Am I making sense? And have you ever thought about it this way?

    1. Great comment Prax… made me stop and think for a few minutes. I’ve had numerous discussions with friends of mine about this (and other related) topics about the merits of value investing. Of course, I think value investing principles work over time and are the simplest way to achieve long term outperformance. The thing I find interesting is why is there such a large disparity between investors that use the same principles. i.e. why do some value investors perform so much better than others?… that’s really what I’m trying to get at here. Some of it has to do with raw ability (like anything, some are just better than others). A large part of it has to do with mindset, and here again, some can control their emotions and way of thinking better than others.

      I could be wrong, and these are just my own thoughts on the matter, but I think a large aspect of these investors’ success have less to do with the time period they worked in, and more to do with two main things…. 1) the principles they decided to employ (i.e. Graham type value principles at a basic level… lots of variations, but the principles are the same), and (maybe more importantly) 2) their ability to truly think differently than the majority of investors.

      The latter point is interesting to me… and as I mentioned in the post, I’ve often wondered why there aren’t more successful investors since value principles are fairly straightforward and relatively simple. At a very basic level, I think the reason for most investors average results is because it’s very difficult to look at things differently.

      This is not to pick on anyone… just an example (there are many like this)… I looked at a well-known investor’s fund the other day. This guy knows value investing. He writes letters, papers, and is frequently mentioned by the media. He’s graduate from a top school (thus he’s quite smart). Why does his fund achieve such mediocre results? He owns a lot of “high quality” businesses, over 50 in all. His largest position is just over 5%, and most of his positions are under 3%. So despite everything he says, the way he has decided to implement the principles he knows so well is doomed to provide–at best–maybe 2-3% better than the S&P. More likely, they will be lucky to keep up with the S&P.

      It’s just hard to own 50+ stocks that (although good businesses) were all purchased at fair prices. So this begs the question… why does he invest using those tactics? Certainly he’s read the same stuff I have, his IQ is likely higher than most other investors, he certainly has studied other investors who have done great over time? Why would he choose to assemble his portfolio in a way that’s destined for average results?

      The only thing I can think of is that he likes managing 9+ figures (1 and 20 is a solid payday on that capital base) and he would rather hug the index and collect his fees than risk suffering an extended period (2-3 years or more) of underperformance (much more likely when you implement a true value strategy)…

      This is not to pick on diversification per se… as I said: the investors who have achieved 20%+ over long periods are usually either diversified deep value guys (Schloss, Graham, etc…) or concentrated (as in 15 or fewer stocks) Buffett-type investors. The ones who have achieved extreme results (30%, 40% or more… i.e. Buffett in the 50’s, Greenblatt in the 80’s and 90’s, Pabrai from ’95-now, Lampert, etc… are all very concentrated).

      But in either case, diversified deep value, or concentrated business investing, there are periods of underperformance, sometimes long periods…

      Think about this… Schloss averaged roughly 21% gross for 47 years… but from 1991 to 1999 he trailed the S&P (from start to finish… there were years that he outperformed). So an investor that started with Schloss at the beginning of the decade and took his money out at the end would have been better off in an index. This is an incredibly long period of underperformance that would have caused most investors to question their style. But Schloss kept doing the same thing he always did, and from 2000-2002 (the year he closed his shop), he dramatically outperformed the market, so much so that it made his record from 1990-2002 much better overall than the S&P.

      Of course, his 47 year record of 21% is almost 11% per year better than average, but he had periods of underwhelming performance. I think it’s those periods that subconsciously cause a lot of investors (even value investors) to do things that aren’t in their best interests.

      So my own empirical observations lead me to two very general conclusions: Buy a lot of cheap stocks, or buy a few quality undervalued stocks. In the end, regardless of how many stocks, it’s really about just owning things that are significantly undervalued. Sounds simple, but not easy (mentally).

      These are more rambling thoughts. As for whether the results indicate the merit of the approach, I would say they do, but certainly time periods matter. But in general, I think the tactics that the investor uses to implement these value principles are much more important than the time period (assuming you have 10 years or more to invest).

      Thanks for the thoughtful comment… interesting topic to consider….

    2. Sir, I would appreciate it if you could explain exactly what makes value investing logically coherent as opposed to technical analysis. I suspect a satisfying answer would need to address the following question: what is the logic behind the fact that undervalued stocks revert to their intrinsic value? (and why can this logic not be applied to technical analysis?)

      1. Technical analysis treats stocks as pieces of paper. It just doesn’t seem logical to trade in and out of stocks based on useless chart patterns and volume. Technical analysis also implies the ability to predict the future. If that were so, traders would be on the cover of Forbes magazine. Value investing treats stocks as equity stake in a corporation, which is what a stock is << this seems like the most logical way to view stocks, no? The idea is that, in the long-run, the market gets it right as investors get more information and momentum traders pile up.

  3. I would wager to say that deep value investing is in many ways contrary to human nature. Munger says that “The money is in the waiting” – and that’s tough to do. It’s tough to sit in a stock where you are invested at 50% below NCAV, and the market does not care…for years. This is especially tough if you are marked quarter to quarter as a professional fund manager, and at some point you lose faith in your thesis, or want to trade around the name, etc. The methods seem dead simple – investing zen is in the stillness.

    I would further venture say the Buffett & Munger stopped being a value investors after he dissolved the original partnerships and they became a large cap growth (or even GARP) investors. But that’s another conversation.

    Stan

    1. Yes the latter is probably true. Although we could also reference Buffett’s “value and growth are joined at the hip” comment from one of his letters. But certainly he shocked a lot of people when he bought Coke at 5x net assets and 15 times earnings. Certainly not a Graham value stock. And he’s continued to make those type purchases since.

      The first part of your comment is very true. It’s easy to comprehend a basic idea from someone like Schloss who says “I hold stocks for an average of 4 years”. Schloss was very patient. An example of this is Gamestop. It wasn’t a net net Graham type stock, but it was cheap. I didn’t hold it, but I know two value guys that bought it in 2009 or 2010 and watched the stock go down by 30% or more at one point. But patience paid off and it’s now up over 100%. There are lots of ideas like that that don’t pay off for 3 or 4 years. But if you make 100% in 4 years, that’s 19% per year (even if 0% came for 3 years and in the 4th year you got all 100% 🙂

  4. hi,john, excellent article. i think that what is importmant for me is that i should stick to my gun regardless of market fluctuation. i fous more on extremely low valuations than quality business. most investors pay more for the quality. great business does not equal great stocks. in my experience, most stocks taking a market beating down can come back and make great ruturns. of course, buying them needs more courage and confidence. Great purchase is always made in face of uncertainty and despair.

    1. That’s right… and I think most investors would do far better if they really started focusing on valuation first, and then quality. The latter is a function of the former, but too many people pay too much for quality. Thanks for the comment Lei.

      1. Thanks for an excellent blog. Regarding the issue of value investors paying too much for quality, the superb book Quantitative Value: A Practitioner’s Guide makes the case that Joel Greenblatt’s magic formula consistently overpays for quality. In other words, all the excessive returns generated by the formula is attributed the pricing part of the formula.

        1. Yeah I’ve read Dr. Gray and Mr. Carlisle’s book. They did great work with it. Lots of interesting things to consider. And basically, I think their process does a good job at forcing value investors to ensure that they focus on valuation first, quality second.

          Thanks for reading…

  5. I wonder how deep value investing works today. I’ve seen bloggers like oddballstocks and whopper who are deep value investors, but I don’t know their long-term records. The best track records I’ve seen are from investors who mainly concentrate in “equity bonds”. Guys like charlie479, Jim Zimmerman, Chris Mittleman, and of course Buffett, Munger, and Pabrai. Mittleman is one of the best I’ve seen who isn’t heavily concentrated. His full position is 5%. His long-term track record is also crazy.

    1. Thanks Jack. Charlie479 does great work at VIC. I haven’t seen his results, but you’re right, there are a lot of value managers who now run more concentrated portfolios. Michael Price still runs a mostly deep value diversified style. I’m not sure of his recent results either, but he averaged 15% for many years with a large mutual fund (and he said it’s easier to manage his own capital which is what he’s doing now).

      There are a few other deep value funds out there… not sure if anyone is doing what Schloss did. Schloss’ results were incredible, and my guess is they still would be if he were still here managing capital.

      Price’s results weren’t quite as good but he seemed bent on reducing volatility and exposure to bear markets more than most other value guys. A third of his portfolio has always mostly been in special situations stocks. My guess is that did a great job insulating his portfolio during stormy bear markets, but it probably didn’t perform as well as his value stocks (the other two thirds). It’s hard to make 20% per year on that many special situations at once (and he owned a lot of them… often 30 or 40 or more).

      Schloss wasn’t concerned much about the overall market, just owning cheap stocks.

      1. hi ,john. i think most investors can do the same as what schloss did in his 65 years. but in fact, few investors can because most investors like glamour or growth stocks. this gives deep value investors an advantage.

        1. Yeah I agree Lei. Like Greenblatt says, value investing works because sometimes it doesn’t. It’s difficult mentally to stick to. Was just looking at a track record today where the investor has averaged 22% per year for over a decade, but had a period from 2002-2008 where the index outperformed him. That’s a long time, and certainly not ideal. But since then he’s averaged 37%. And he outperformed prior to that as well. So it sometimes is difficult. Even Schloss spent the majority of the 90’s outperforming. But taken as a whole, his record is one of the best ever… Tough to stick to…

          1. Yep… Schloss was the master at keeping things simple, and sticking to the basic value principles. Thanks for reading Lei.

    2. Jack,

      My ears were burning… I have often stated that my goal is to do 15-20% over the long term. I know with the rising market it’s common to look at people doing less than 20% a year as somehow failing, but I would be satisfied with 15%. As to how I’m doing, I have surpassed my target. The true test is how I do in a down market, that’s where money is made.

      This conversation is interesting. I agree with whoever above me said that Buffett is more of a GARP investor, I also believe he’s the Michael Jordan of investing. We can try to imitate him all day long but we’ll never come close to matching him. Whereas Graham developed a system that anyone could use, Schloss is a great example.

      Nate

      1. hi.nate,i often read your blog. yes, most investors can imitate schloss. great business at reasonable price is not enough for small investors. i need huge margin of saftey. i follow schloss.
        lei

      2. I agree Nate… over the long term, I would expect the broad market to yield 5% or so before dividends (maybe 7-8% including dividends). So 15% returns over time will yield incredible outperformance (not to mention the incredible absolute results you’ll get from organically compounding the account at those levels).

        Schloss achieved 20% returns over 47 years, which is astounding when you begin to crunch those numbers… your basic strategy seems similar (at least from what I can gather from reading your ideas), and I believe will likely achieve your intended result over time. 15% is incredible, and is rarely repeated. I think I mentioned this in one of my earlier comments, and you eluded to it in your comment, but it’s for most people to stick to such a strategy. Schloss underperformed from 1990-1998… that’s a 9 year period of underperformance, despite a 47 year record of trouncing the overall market. People abandon good strategies in bull markets for certain reasons, and in bear markets for other reasons.

        Thus one of the reasons why such things continue to work over time.

        And I agree regarding Buffett/Munger and other qualitative guys. I think of them as business analysts, whereas Schloss and Graham were more security analysts. They invested in ways that individuals could easily replicate, if they could master the discipline and the mindset.

        Thanks for the comment Nate…

  6. I agree with your conclusions but I think there is another way that blends cheapness and focus. That is to purchase cheap stocks in growing businesses that aren’t great businesses but good enough businesses. The other aspect that Marks intuitively is good at is credit analysis. I have found many of the above mentioned types of businesses have debt. The real question is how much is too much and credit analysis has helped me there. I have followed this type of approach (good enough businesses at cheap prices and sometimes non-recourse leverage via LT options with portfolio concentration by how cheap they are) for about 5 years. The results have been good with annualized returns of 58% for the last 5 years (but part of it may be the bull market since 2009 and part luck). There is a good amount of volatility with a 51.4% decline in 2008. I really agree with Marks that price has to come first and do not understand why an analyst can estimate an intrinsic value, observe a price and not use the two pieces of information to weight their holdings.

    Packer

    1. Thanks for the comment Packer. Great results… yeah I’ve explored the concept of “non-recourse” leverage considerably… I mostly prefer cheap stocks that have clean balance sheets, but within the context of a portfolio, a small portion in stocks using this type of non-recourse leverage (which I would define as equity stub type investments, or stocks where the equity is a small sliver of the overall capitalization…. or LEAPS or some other security with embedded leverage). I prefer the equities because there is no hard expiration date (although often heavily indebted companies don’t have time on their side).

      But they can produce big returns. Private equity guys can vouch for that! Greenblatt talks alot about this in his first book as well.

        1. Hi Lei, yes, some companies will purchase assets and finance them with non-recourse leverage. In this instance, the “non-recourse” leverage I was referring to was at the portfolio level. It simply means that you can buy a stock that has leverage at the company level, but your holding doesn’t require leverage (as an investor, you don’t borrow money to take the position… your leverage comes indirectly through the stock, but you don’t have any liability beyond the amount of your investment).

      1. hi,john, i have an example for the stub stock. that is Excel Maritime Carriers, Ltd. (EXMCQ). i buyed at 0.05 and now it is priced at 0.31

        1. Most of the stub stocks that have worked for me have been levered but have had improving credit profiles and not in bankruptcy. Examples include: LIN, GTN and NXST.

          Packer

  7. I think in emerging countries like India Quality at reasonable price still works. In fact you can often find deep value stocks that are average quality businesses which are growing over a period. But even in India I see many investors following Buffett blindly and only trying to buy high quality businesses. In the process they comprise on their returns. Deep value crowd is really rare and getting rarer due to people like Buffett and Munger etc. Graham in his lecture talked about U shaped market. On the left crappy business so speculative. On the right Blue chips with high valuation and hence speculative. In the middle many stocks of average companies growing at GDP rate which you may find at attractive valuation if you search hard enough. He advised us to buy those stocks. I agree with him. These deep value stocks belonging to reasonably OK businesses with low debt and reasonable moderate growth over long run is what you should look for.

    1. Interesting comment Giri. I actually think there is probably value at times in all different spots along the “quality” spectrum. Sometimes extremely high quality companies get hugely mispriced, and sometimes as you say companies that are just average quality also see their share prices unduly discounted. It just depends. I think your idea can work (focusing on only a certain portion of the market), but I would probably prefer to simply just focus on finding big gaps between price and value, wherever they are. Sometimes they are in mega caps and sometimes you find them in micro caps. As a general guideline, I have decided I don’t want to own crappy companies, but I do look for both compounders and bargains or special situations in the average company as well.

  8. Hi John…I have encountered now this post (excellent as usual!) and I have used for Buffett the returns by BRK stock instead of book value (thanks that he is including that number in the annual letter) and I have found that in those years of comparison… Buffett gets a 17.96% annualized return- the second after Munger- but in the years between 1975 and 1983 he obtained an astonishing 54.19% annualized. Just for a new refreshment of the article.

  9. Great blog, love it, only started reading it a month or so ago.

    I would like to add that from the Snowball bio of Buffett, it seems towards to end of his partnership he actually had mixed holdings between cigar butts and “great” businesses.

  10. HI, I like this article, and come back to reread it time to time. My question is why was Munger down so much compared to the market in those two years? 73 and 74….. What was about his style, or the investments he had contributed to this? thanks…..

    1. Hi Brad, Munger was very concentrated. I don’t know offhand specifically what investments he was in, but I believe Snowball might outline a few of them. He tended to be very concentrated, and he also liked good businesses, which became overvalued leading up to that downturn. That caused the significant volatility in Munger’s portfolio, and also helped the subsequent rebound in 1975. But I am just hypothesizing here. I really don’t know what his portfolio consisted of exactly. If anyone finds any specifics on it, that would be interesting. I’ll be at the Daily Journal annual meeting next month, so maybe that’s a great question to ask him.

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