Walter Schloss' 16 Factors Needed to Make Money in the Stock Market ~ market folly

Thursday, October 4, 2012

Walter Schloss' 16 Factors Needed to Make Money in the Stock Market

Today we present rules of investing from Walter Schloss, founder of Walter & Edwin Schloss Associates LP.  He was one of the best investors of our time with over 15% CAGR between 1956 and 2000 and unfortunately passed away early this year.

In an old document dated March 10, 1994, Schloss outlined the following principles for becoming better investors

16 Factors Needed to Make Money in the Stock Market

1.  "Price is the most important factor to use in relation to value."  

Warren Buffett's famous quote is the perfect complement: "price is what you pay, value is what you get."

2. "Try to establish the value of the company.  Remember that a share of stock represents a part of a business and is not just a piece of paper." 

Indeed, Warren Buffett has long preached this principle as it's important to set your frame of mind and how you look at things.

3. "Use book value as a starting point to try and establish the value of the enterprise.  Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock)."

4. "Have patience.  Stocks don't go up immediately." 

Value investors everywhere live by this adage but many prominent long/short hedge funds also focus on the concept of 'time arbitrage': waiting for the market to come to the same realization you have regarding the valuation/opportunity of a specific security.

5. "Don't buy on tips or for a quick move.  Let the professionals do that, if they can.  Don't sell on bad news."

Modern hedgies might argue against that last sentence because sometimes bad news is a warning sign of more impending problems at a company.  At the very least, bad news usually merits further due diligence. 

Leon Cooperman of Omega Advisors takes this concept one step further by outlining his rules for portfolio managers: if you have conviction in a name and it's down, buy more.

6.  "Don't be afraid to be a loner but be sure that you are correct in your judgment.  You can't be 100% certain but try to look for weaknesses in your thinking.  Buy on a scale and sell on a scale up."

The key in this rule is to look for weaknesses in your thinking.  As Warren Buffett's partner Charlie Munger says, "invert, always invert."  Examine the variant perception and the bear case if you're long a company.  The best investors focus on the downside even more-so than the upside.

7. "Have the courage of your convictions once you have made a decision."

A very important and often under-mentioned aspect of investing.

8. "Have a philosophy of investment and try to follow it.  The above is a way that I've found successful."

Warren Buffett obviously says to "stick to your circle of competence" and Peter Lynch says to "invest in what you know" in his golden rules of investing.

9. "Don't be in too much of a hurry to sell.  If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit.  Before selling try to reevaluate the company again and see where the stock sells in relation to its book value.  Be aware of the level of the stock market.  Are yields low and P-E ratios high.  If the stock market historically high.  Are people very optimistic etc?"

10. "When buying a stock, I find it helpful to buy near the low of the past few years.  A stock may go as high as 125 and then decline to 60 and you think it attractive.  3 years before the stock sold at 20 which shows that there is some vulnerability in it."

11.  "Try to buy assets at a discount than to buy earnings.  Earnings can change dramatically in a short time.  Usually assets change slowly.  One has to know how much more about a company if one buys earnings."

12.  "Listens to suggestions from people you respect.  This doesn't mean you have to accept them.  Remember it's your money and generally it is harder to keep money than to make it.  Once you lose a lot of money it is hard to make it back."

This is what strives to provide on a daily basis.  There are many great investors out there, so why not at least see what they're up to and use it as a starting point to do further research?

13. "Try not to let your emotions affect your judgment.  Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks."

Surprised this rule isn't higher up on his list, but then again he was a patient value investor so this probably wasn't a problem for him.  This was our top answer for advice for new investors.

14.  "Remember the word compounding.  For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded.  Remember the rule of 72.  Your rate of return into 72 will tell you the number of years to double your money."

15. "Prefer stocks over bonds.  Bonds will limit your gains and inflation will reduce your purchasing power."

16.  Be careful of leverage.  It can go against you."

Example: see the financial crisis of 2008 as the perfect example: Look at where Lehman Brothers' 31:1 leverage landed them.

For those of you who want a copy of Schloss' original document from 1994, it's embedded below:

For more wisdom on becoming a better investor, see these great resources we've compiled:

- Top 25 Warren Buffett quotes

- Peter Lynch's golden rules of investing

- Leon Cooperman's 14 attributes that make a good portfolio manager

- George Soros' best investment advice

- Lessons Dan Loeb learned as an investor

- Bruce Berkowitz's checklist for investing

- Peter Lynch on using your edge

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