Value Investing

by Charles Mizrahi

Related gurus’ buys/sells:

*The price and date might not be the actual time and price at which the transactions were made. In the case of institutional owners, the date is stated as the last day of their fiscal quarter. The prices are estimates if no accurate information available. I could never understand the logic of multibillion-dollar corporations with tens of thousands of employees, in offices around the world, offering quarterly earnings estimates. How is it possible that they are able to provide an exact number for their earnings every quarter? Even more puzzling, how is it possible for securities analysts to even target what earnings are going to be every quarter? There are so many different variables that it seems impossible to predict, yet many times analysts hit the nail on the head right down to the penny!

There is a trend now in boardrooms of publicly traded companies to stop this nonsense. The National Investor Relations Institute (NIRI), in a March survey, said that publicly traded companies giving out quarterly earnings guidance fell to 52% from 61% a year ago. Many are coming to realize that offering quarterly guidance promotes what Louis Thompson Jr., president of NIRI, called “short-termism.”

Giving earnings guidance, especially every 90 days, does more harm than good. If the focus is on “beating the numbers,” then corporate managers are focused on matching or exceeding a number every quarter, and that has them taking their eye off of managing the business for the long term.

Woe to the company that misses its earnings forecast by one penny. Many times the stock gets pummeled. Billions of dollars of market capitalization can be lost in less time than it takes to drink a cup of coffee and all because of one penny.

Some big-name companies no longer give quarterly guidance, companies such as Motorola (MT), Coca-Cola (KO), the Washington Post Company (WPO) and Campbell Soup (CPB). A few years back McDonald’s led the pack by ceasing quarterly and annual guidance.

This is a trend that I hope continues. Investors and corporations should stop focusing on the short term and realize that the big money is made over time.
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Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 23 years experience in the financial world as a money manager and investor. Email:, Webpage:

Published Third Quarter 2006
Muhlenkamp Memorandum 79

by Ron Muhlenkamp   
Economic trends of the past year continue. The economy is growing nicely in the 3% – 3½% range and inflation remains contained in the 2%+ range. If you monitor these numbers, you might think I’m crazy because the GDP in the fourth quarter was about 1.7% (largely due to the hurricanes) and in the first quarter was about 5.7% (largely due to the rebound after the hurricanes). Similarly, inflation numbers have been higher, particularly when food and energy (always volatile) are included. So, reported numbers in GDP and inflation have been quite volatile. Similarly, the stock and bond markets (both domestic and foreign) have become quite volatile. Some parts of it we foresaw; some we
didn’t. (See the following essays “Looking for a Rich Harvest,” “Questions and Responses” and the “Muhlenkamp Minute.”) Suffice it to say that part of our job is to shield your assets when markets turn volatile on the downside, and we haven’t done that to our standard in the recent months.

I have frequently been asked to compare the current economy and markets to prior periods. In this vein, I believe the following:
• The economic and investment climate is most similar to the early 1960s; good GDP growth and contained inflation.
• The current stage of the business cycle looks most like 1994-1995 —
a soft landing or slowdown after a nice recovery from recession.
• The current psychology and market action are volatile. There is so much money, managed both professionally and privately, which is seeking to latch onto the latest fad or trend and then to be the first
one off (which is the hard part) that the markets will remain quite volatile. We think this will continue.

Many think that volatility is a bad thing. We think it is a good thing, allowing us to buy cheap or sell dear.

Because we like the climate and the seasons and, most importantly, we think we’re finding good companies at cheap prices (some of
which we own — and have gotten cheaper), we think it’s an opportune time to be investing money in our companies’ stocks.

The comments made by Ron Muhlenkamp in this article are his opinion and are not intended to be investment advice or a forecast of future events. Copies of past newsletters are available on our web site at


Read our quarterly newsletter, Muhlenkamp Memorandum, for more by Ron Muhlenkamp.

By Brian Zen,

Value investors never hesitate when they ask “What’s the bad news?” and “What’s wrong?” Last year, Seth Klarman talked about the bad news of value investing and complained that the field is getting too crowded. On February 16 th, 2006, Martin Whitman went further to make a list about what’s wrong with value investing in his talk at NYSSA. (An earlier article on Whitman’s talk can be read here: Marty Whitman’s “Cowardly” Safe-and-Cheap Way to Invest.)

The Problems with Value Investing

“There are a lot of things wrong with what we do,” said Marty Whitman.

1) Compared to people who stare at the charts, value investors have tons of documents to read. Marty Whitman himself hired 17 analysts reading all those documents. It’s very labor-intensive.

2) In order to get quality assets on the cheap, the near term outlook often sucks.

3) “Safe and cheap” companies often have the problems of low return on equity (ROE) due to concentration in underutilized assets positioned too conservatively. Management with whom Marty Whitman go to bed are just as conservative or even more conservative than Whitman himself. The management is often non-promotional people who don’t need Wall Street. They don’t care. One of the things that Whitman found with having competent management is that, the strong balance sheet allows them to be opportunistic. The management’s ability to opportunistically take advantage of market inefficiencies has probably accounted for Whitman’s 10 baggers more than anything else. When ultra conservative balance sheets meets opportunistic and able managers, a number of low ROE stocks turned into 10 or 20 baggers for Whitman as excess cash was converted into future earnings.

4) The safe and cheap investor is often subject to leverage buy out (LBO), management buy out (MBO), “take-under”, or “going private” phenomenon. Most of Marty Whitman’s positions were exited via takeovers. A lot of resource conversions, spin-offs, and liquidations happen within Whitman’s portfolio.

5) Cheap stocks suffer the problems of poor marketability and liquidity. They are subject to the “roach motel” problem — easy to check in, but very hard to check out. Thus, the returns are lumpy. Marty Whitman tries to avoid investment risk, or permanent impairment of capital. He pays no attention to market risk, or short-term price fluctuations. “If I recommend something, it soon goes down 20 percent,” says Marty Whitman.

6) To be safe and cheap, you have to turn down a lot of ideas also. So you would miss a lot of good stuff that is a little pricy.

The Tao of Selling

Most of Marty Whitman’s sellings are a result of resource conversion activity such as mergers, acquisitions, spin-offs, restructurings, etc. He would consider selling a security in the open market if:

1) as a portfolio consideration, the security appreciates and becomes excessively over-weighted in the fund;

2) a security becomes grossly overvalued; (They won’t sell if something is moderately overvalued.)

3) a company experiences, or appears to have the potential for, a permanent impairment of capital; or,

4) their analysis was flawed and they made a mistake.

Marty Whitman has no hard-and-fast rules for selling. And he doesn’t sell much. Their turnover rate is 16% in an active year. In essence, he doesn’t depend on the stock market to deliver profits to him. He relies on the private market. Just like Warren Buffett, if the stock market is closed for five years, Marty Whitman wouldn’t care. His investing style doesn’t really depend on how the public stock market does. “If I’m right, these very undervalued companies will be taken over, liquidated or refinanced, and that’s where you make your money,” said Whitman.

According to Whitman, the “Safe and Cheap” approach works a lot better on the buy side than on the sell side. He sold many stocks after a double and then watched them triple in a hurry. So nowadays he tends to hold on to the moderately overvalued issues.

The Art of Distress Investing

In value investing, chapter 11 is the end. In distress investing, Chapter 11 is the beginning.

Marty Whitman looks for the senior-most debt issues and tries to get at least 500 basis points more in yield versus comparable credit. He would like to buy 50% or more of the senior debt of troubled companies at 15 to 20% yield to maturity. If it has to be reorganized, he converts all the senior issues into common stock. In some cases, there are prepackaged deals. He also buys into the debt of larger companies where his ownership percentages would be a lot less. He would be very interested if GM files bankruptcy.

In distress investing, the play-it-safe Marty Whitman doesn’t want to be subordinate to any liabilities ahead of his claim, including off-balance-sheet liabilities. “We never did anything with tobacco stocks. In the history of Third Avenue, we virtually had no investments in old line manufacturing companies. After being investors in John Mansville credits, there is no way we would want to be junior to asbestos liabilities. There is virtually no old line manufacturing company that does not have asbestos liabilities,” said Marty Whitman. And he missed the upside in the USG stock, which makes an interesting case study about the flip side of the “safe and cheap” approach.

Marty Whitman looks for debt issues that will never miss a payment, such as those of GMAC and CIT when it was controlled by Tyco. They have made huge amount of money in distressed situations like Nabors and Public Service of New Hampshire. He also buys a lot of trade claims.

But Marty Whitman has his share of blow-ups in distress investing. It’s much like venture capital. “We have a high strikeout ratio. It’s not easy,” said Whitman.

The Huge Cost Of Reorganization

We all know that American CEO’s are overpaid. But CEO’s pay is nothing compared to the pay of bankruptcy professionals, said Marty Whitman. The cost of Enron’s reorganization is $1 billion. And pre-petition creditors are paying for that. The key here is to shorten the process of reorganization. Bankruptcy administrative costs are payable in cash. You pay as you go. So the bankruptcy professionals have all the incentives to prolong the process. Marty Whitman told the following joke about bankruptcy lawyers:

A prominent bankruptcy attorney died young on his way to court, and found himself before the gates of Heaven. When he arrived, a chorus of angels appeared, singing in his honor. St. Peter himself came out to shake his hand. “Mr. Jones,” said St. Peter, “it is a great honor to have you here at last. You broke the world record for longevity. You are older than Methuselah!”

“But I am only 40,” said the attorney, “You must have made a mistake, Sir.”

“No mistake here,” said St. Peter confidently. “We have been carefully adding up the hours on your time sheets. You have lived 1,028 years!”

Global Values: Cheaper but Less Safe

Since the “safe and cheap” are becoming more difficult to find in America, Marty Whitman is now shopping in places like Hong Kong, Singapore and Japan. There are real risk of investing in foreign issues even though they are local blue chips, with financials audited by the Big Four because you are investing in jurisdictions where you don’t get protection from the U.S. security laws. “Foreign issues are cheaper but less safe. You have communists crawling all over Hong Kong,” laughed Marty Whitman, who estimated that foreign issuers are now approaching 50 percent of his portfolio.

“Because of Sarbanes Oxley, no foreign issuer like Toyota Industries will be willing subject to our jurisdiction unless they really need our capital. I think Sarbanes Oxley is screwing up our capital markets for foreign issuers and small companies,” said Marty Whitman, who is known for his capacity for critical thinking. “We used to require that they have disclosures published in English, audited by the big four, with ADR trading in the U.S. Now we are dropping the ADR requirement because of Sarbanes Oxley.”

For people used to the American culture, it is a lot harder to venture overseas. You need to understand foreign accounting rules also. For example, Hong Kong public companies list their fixed assets at appraisal value.

Top-Down vs. Bottom-Up

Martin Whitman believes that most people on Wall Street are top-down and those guys are still living in the 1930’s. For the 70 years after the Great Depression, virtually every industry in the U.S. has gone through some sort of depression with similar magnitude of the 1930’s saga. Yet the economy of the whole country never went through a depression ever since. The last time that global events were more important to long-term investors than the company-specific valuation deals in moving the stock market was 1933. “Bottom-up company and industry analysis counts a lot more, and top-down economy analysis is less meaningful nowadays,” said Marty Whitman.

When asked how he sees his firm’s future 10 years from now? Marty answered: “Well, I am in my 82nd year. (Applause) I assume we would do very well, and they would get rid of me. Or I may [go ga-ga], which may happen in another two weeks.”

Don’t be so fast, Mr. Whitman. St. Peter told me that your time sheet is not long enough due to your career switch. How about a few more cheap ones with star potential hiding on a safe bed and a few more jaw-opening moments?


Brian Zen, CFA, PhD, is the founder of Inc., an investment research firm that publishes Superinvestor Digest and provides training and advisory services to investors and analysts. Complete notes of Martin Whitman’s talk at NYSSA can be requested from Brian at:

by James Montier

Occasionally when I present on the seven sins of fund management, someone at the end (obviously a valiant soul who has managed to stay awake) will ask me how I would structure an investment process. In the spirit of good politicians everywhere, I am going to save my answer to that question for another weekly. However, I recently read a paper along similar lines that I thought was worth sharing. Louis Lowenstein of Columbia University examined 10 value managers selected by Bob Goldfarb, CEO of Sequoia Fund. Lowenstein asked him to select ten dyed-in-the-wool value investors who all followed the essential edicts of Graham and Dodd; obligingly, Goldfarb selected the list below. To this list we have added a second Tweedy Browne fund, Tweedy Browne Global Value.

This may not be the most scientific of approaches, but nonetheless should allow us to draw out some of the characteristic behaviors of some of the best value investors. We have updated and extended Lowenstein’s work.

The table below shows the funds and some of their key characteristics.

Trait I: High concentration in portfolios

Contrary to the proclamations of classical finance, these investors tend to run highly concentrated portfolios. No portfolio diversification for these guys. Tracking error has little or no meaning to this group of investors.

Across these funds, on average, nearly 40% of the assets are in the top ten holdings. Across a wide universe of funds, the top ten holdings account for only around 10% of assets. The average number of stocks held is around 35 (and this is raised by the presence of three international funds, it would be closer to 20 for the domestic-only funds). In contrast, the average US domestic mutual fund holds around 160 stocks!

This seems to reflect a different philosophy on two counts. Firstly, these value managers seem to need a reason to invest – not investing is their default, so in order to actually go out and buy a stock, these investors need to be convinced of the merits. Presumably in accordance with Graham and Dodd’s guiding principles, this is represented by a margin of safety. As Graham wrote, “The margin of safety is the central concept of investment. A true margin of safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience”.

Secondly, the average fund management outfit appears to be run either by the risk management department or the marketing department. I’ve come across several examples of this in the last few years. One client was relaying to me the joys of his risk managers telling him that he had to deploy more risk, because he was under his risk budget! Of course, when markets fall, those very same risk managers with their trailing correlation and volatility will be the first in line to tell you to sell your positions. Risk managers are the financial equivalent of those who give out umbrellas on dry days, but snatch them back as soon as it starts to rain.

Another informed me that they were setting up a commodity fund. Why? Because the marketing department said there was an appetite for such a product. Does this not strike anyone as vaguely (and perhaps alarmingly) like the TMT bubble?

The result of these bizarre dynamics is that the average fund manager is more worried about tracking error and benchmark risk, than about finding the best investment for his clients. So their default is likely to be ownership. Hence they need a good reason not to invest in a stock. The fiduciary responsibility to the client is forced to take a backseat. Perhaps investment managers should take an equivalent of the Hippocratic Oath to do no harm.

As is often the case, Maynard Keynes sided with the value investors. He wrote:

To suppose that safety-first consists in having a small gamble in a large number of different companies where I have no information to reach a good judgement, as compared with a substantial stake in a company where one’s information is adequate, strikes me as a travesty of investment policy.

Letter to F.C. Scott, February 6, 1942 (The collected writings of John Maynard Keynes).

This was a view shared by Loeb in his classic, The Battle for Investment Survival. He opined, “Diversification is an admission of not knowing what to do, and an effort to strike an average”.

It should be noted that concentrated portfolios are not, in and of themselves, a deliberate choice on the part of these funds, but rather stem from their investment discipline. There simply aren’t that many good value opportunities to be found. The Brandes Institute published a paper in late 2004 exploring the use of concentrated portfolios. They concluded, “In aggregate, and across peer groups, we find that concentrated portfolios, in and of themselves, do not provide improved returns, nor do they provide improved volatility-adjusted returns”. This emphasizes the fact that the concentration amongst our group of value investors is the result of a process rather than a deliberate decision in its own right.

A graphic illustration of this point can be seen by examining the performance of a basket of stocks that Fortune assembled in the year 2000. The basket was labeled “10 stocks to last the decade – here’s a buy-and-forget portfolio”. The aim of the stocks was to allow you to “retire when ready”, according to Lowenstein. The list of companies is shown below. Only one of these stocks had a PE of less then 50x!

The performance of this basket is shown in the chart below. At least Fortune got one thing right – it was a portfolio to forget! It is still down around 40% from the time at which Fortune suggested its purchase. A prime example of what Ben Graham would have described as a permanent loss of capital.

The investors in our value group focus themselves upon business risk – will profit margins shrink? Are there risks on the balance sheet? – rather than market risk (stock volatility), which these investors seem to treat with the scorn it deserves. They know that the market as a whole is best characterized as suffering bipolar disorder (the proper name for manic depression). As Ben Graham wrote:

One of your partners, named Mr. Market, is very obliging, indeed. Everyday he tells you what he thinks your interest is worth and furthermore offers either to buy you out or sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or fears run away with him, and the value he proposes seems to you a little short of silly.

Trait II: They don’t need to know everything, and don’t get caught in the noise

The investors in this group seem to be aware of the need to focus on a few key items of information, rather than attempting to try and overload themselves with noise. Lowenstein quotes Marty Whitman of the Third Avenue Value Fund as saying, “the fund doesn’t have superior information; ?the trick’ is to use publicly available information in a superior manner”. To this end, these funds don’t employ legions of analysts wasting time forecasting next quarter’s EPS; instead, they spend their time trying to understand the valuation and associated risks.

Trait III: A willingness to hold cash

Their willingness to hold cash is clearly visible from a cursory glance at the table on page 2. Currently they hold around 11% cash, nearly 3x the level held in the average US mutual fund. The average hides a wide range of current cash levels. For instance, FPA Capital is holding nearly 39% cash whilst Legg Mason Value holds a mere 1.1% cash.

Most of the traits displayed stem from the underlying philosophy of the funds in question. The generalized willingness to hold cash is the result of lack of investment opportunities. In his year-end letter to shareholders of 2003, Seth Klarman wrote that his large cash position was the “result of a bottom-up [and failed] search for bargains”. The guiding principle amongst our group of value gurus is, to borrow Buffett’s expression, “holding cash is uncomfortable, but not as uncomfortable as doing something stupid”.

Trait IV: Long time horizons

I have often remarked that inherent within a value approach is the acceptance of long time horizons. You never know when a stock will reflect a sensible value. A good example was provided by the UK market in early 2003. The dividend yield on the UK market was higher than the 10-year government bond yield, suggesting that dividends were expected to decline on a decade view. This struck me as just plain wrong. A plethora of valuation work showed the UK to be unambiguously cheap (for details see Global Equity Strategy, 30 January 2003). The presence of forced sellers was making the UK market a bargain.

However, as with all bargains, they can repay you in one of two ways. Firstly, prices could correct. Secondly, they could just generate a high return via paying out high dividends for a long period of time. You never know which path will be taken. Hence the need for long time horizons.

Our selection of value managers all display long horizons. The average stock-holding period amongst these funds is over five years. The maximum is 17 years, the shortest 3 years. All compare favorably with the mutual fund industry’s average stock-holding period of just 1 year (according to Morningstar).

This is supported by the chart below showing that average holding period for stocks on the NYSE. Back in the 1950s/1960s, investors used to do exactly that: invest. The average holding period was 7-8 years. However, today it appears as if everyone has become a speculator, with an average holding period of just 11 months.

When I present these findings, investors often dismiss the picture as yet further evidence of the way in which hedge funds have altered the investment landscape. However, the Morningstar data above, and the data from John Bogle below, show that long-only fund managers are just as much to blame for the time horizon shrinkage as the hedge funds. This may be because they feel the need to compete with the hedge funds but, regardless, they are certainly complicit in the shift from investment to speculation.

As Munger and Buffett have noted on many occasions, “If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never”.

Trait V: An acceptance of bad years

Nearly all of the funds in our list have witnessed periods of negative returns, and/or underperformance relative to a benchmark (although note Trait I on the disregard for such items). Many of them saw large redemptions during the TMT bubble, but were prepared to stick to their tried and tested approach to investing. Lowenstein cites Eveillard (manager of the First Eagle Global Fund) as saying, “I would rather lose half my shareholders than lose half my shareholders’ money”.

Despite the very impressive performance data contained in the table on page 2, many of the funds examined have underperformed the index in as many as seven years out of the last ten! Absolute losses are relatively rare, with only 2 or 3 years seeing negative returns in the last 10.

In a paper published by Tweedy Browne, they report a study that showed for a group of value investors with excellent long-term track records, that underperforming an index some 30-40% of the time was perfectly normal. This fits well with our previous study of underperformance using an artificial universe of skilled fund managers who, despite having an information ratio of 0.5, saw 70% of their numbers witness 3 or more years of consecutive underperformance (see Global Equity Strategy, 7 June 2005).