I am a fan of value investing in all of its different variations, and so when I run across a book on the topic, particularly from a skilled practitioner, I buy it. I’ll do more book reviews on value investing, but one of the first that I wanted to do was Value Investing, by Marty Whitman.
So, I start looking around for my copy, and I can’t find it. Arrrgh, I can guess what happened. I lent it out, I can’t remember who I lent it to, but the borrower never gave it back to me. Annoyed at myself, I do notice a book that was just as good, The Aggressive Conservative Investor, by Marty Whitman and Martin Shubik. Even better, it is back in print, after being out of print for 20+ years.
So, what’s so great about the book? (Most of this applies to both books.) Marty Whitman has a strong “What can go wrong” approach. He realizes that he, and most other investors, will be outside passive minority investors. We only ride on the bus. The inside active control investors drive the bus, and if we are going to make money with reasonable safety, we have to understand the motives of those that control the companies. They benefit somewhat disproportionately from control. They receive wages and benefits that other shareholders do not receive, can gain cheap outside financing, and limit tax exposures, in addition to other benefits.
Like me, Whitman doesn’t care much for modern portfolio theory. More notable for a value investor, he has a few criticisms for the traditional “Graham-and-Dodd” type of value investing:
- Typically, it works best for “going concern” situations, and not situations where activism could be necessary to unlock value. (Though, Graham did do things like that in his career; he just didn’t try to teach amateurs about it.)
- He doesn’t always stick to high quality companies, if enough information can be obtained about the target. Information allows for more risk to be taken.
There are four things that he insists on in equity investments:
- Strong financial position
- Honest management that is creditor-aware and shareholder-oriented
- Adequate disclosure of information relevant to the success of the company
- The stock can be bought for less than the net asset value (adjusted book value) of the firm.
If you have these items in place, you won’t lose much, and if the management team makes value enhancing decisions, one can make a lot of money on the stock.
Whitman places a lot of stress on reading through the documents filed with the SEC. They may not be perfect, but managements know that they need to provide adequate disclosure of material information, or they could be sued. A lot gets revealed in SEC filings, and not every investor sees that.
He also places great stress on understanding the limitations of the accounting, whether under GAAP, Tax, or any other basis. Comparing the various accounting bases can sometimes illuminate the true financial well-being of a company. (Note: this is what killed me on Scottish Re. I should have questioned the GAAP profitability, when they never paid taxes.) He lists the underlying assumptions behind GAAP accounting, and explains how they can distort the estimation of economic value. Honestly, it is worse today in some ways than when he wrote the First Edition in 1979. GAAP accounting is more flexible, and less comparable across companies today.
Marty Whitman looks for situations where resources in a company can be used in a better manner, creating value in the process:
- Is the company too conservatively financed? Perhaps borrowing money to buy back stock, or issuing a special dividend could unlock value.
- Are there divisions that are undermanaged, or would fit better in another company?
- Are management incentives properly aligned with shareholders?
- Would the company be better off going private?
- Is government regulation a help or a hindrance? (Barriers to entry)
- Analyzing corporate structures for where the value is.
Beyond that, he explains how to calculate net asset values, as distinct from book values. He describes the problems with earnings as a value metric. He explains the value of dividends and other distributions. He also explains when it can make sense to own companies that are losing money. (Underlying values are growing in a way that the tax accounting basis does not catch.)
It’s a good book. Together with Value Investing, it gives you a full picture of how Marty Whitman thinks about value investing. He is one of the leading value investors of our time, but he has spent more time than most on the underlying theory. For those who want to think more deeply about value investing, Marty Whitman is a highly recommended read. For those wanting still more, read his shareholder letters here.
Full disclosure: if you use the links on this page to buy these books, I receive a small commission.
PS — Twelve years ago, I wrote Marty Whitman, begging to be one of his analysts. Though I didn’t get a response, I still admire him and his staff greatly.