Walter Schloss Part Three: The Magic Of

Compounding
valuewalk.com /2015/01/walter-schloss-investment-style/
Rupert Hargreaves
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<span class="textnode">I read this
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This
is Walter
part three of a multi-part series on Walter Schloss, legendary value investor. To ensure you do
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rest of the series sign up for our free newsletter. Parts one and two can be found at the
Schloss
Part
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Three: Thelinks
Magic
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2. Part two
lk.com/2015/01/wal
ter-schlossWalter
Schloss Part three: The Magic Of Compounding
investment-style/.
You are not
subscribed
anyseries starts with a letter, typed on February 3rd 1976, from an investor whose
Part
three oftothis
newsletter.
If
you
reputation had grown to the point where a rumor that the was buying a stock, was enough to shoot its
wish to subscribe
price up 10%. This investor was called Warren E. Buffett and what follows is a letter he wrote to
to our free
members
the "Buffett Group" before its Hilton Head conference in 1976:
newsletterofplease
follow this link
http://www.valuewa
lk.com/sign-email/.
Warren E. Buffett
</span>
1440 Kiewit Plaza
Omaha, Nebraska 68131
February 3rd, 1976
To the Hilton Head Group
Dear Gang,
Normally, when you get a letter from the wife, partner or secretary of Joe Glutz saying,
"Of course, Joe is too modest to tell you about this himself, but I know you want to hear
that...", it means that Joe is standing over the writer with a gun at his head, telling him
not to look up from the Xerox Corp (NYSE:XRX) machine until the mailing has been
completed.
This one is for real.
Today I received the 1975 annual letter of Walter J. Schloss Associates, which included
a 20-year compilation of Walter's record since he left Graham-Newman. You may
remember I went to work for Graham-Newman in 1954.
Walter left in 1955. And ... Graham-Newman closed up in 1956. I would prefer not to
dwell on the implications of this sequence.
In any event, armed only with a monthly stock guide, a sophisticated style acquired
largely from association with me, a sub-lease on a portion of a closet at Tweedy,

Browne and a group of partners whose names were straight from a roll call at Ellis
Island, Walter strode forth to do battle with the S&P.
On the following page is a re-cap of his yearly performance and calculations I have
made regarding compounded results. The difference between the gross results and the
limited partners' results is accounted for by the fact that, as General Partner, he takes
25% of the profits - a quaint, easy-to-calculate method of tribute not entirely foreign to
many of you.
Walter Schloss has had five down years compared to seven for the S&P. His superiority
in such down years would indicate that not only is he a man for all seasons, but that he
has special strength when facing a head wind. Maybe all of you had better watch Ben
Graham on Wall Street Week this Friday.
As for me, I'm going right out and buy some Hudson Pulp & Paper.

Best,
/s/ Warren

The above letter was not the only time Buffett wrote to his partners commending Walter Schloss' skill.
The Oracle of Omaha penned another note nearly two decades later. A copy of both letters, including
Schloss annual returns can be found here.
Its clear from Buffett's correspondence that he had a huge respect for Walter. Both of the legendary
investors spent time learning their trade with Benjamin Graham and both understood the true meaning
of deep-value investing.
Indeed, both Buffett and Walter Schloss were cast from the same deep-value Benjamin Graham mold,
but by the late 70s, early 80s the two investors were moving in different directions. Buffett for example
was looking for quality at a reasonable price, buying Coke and Gillette, while Schloss stuck to his
deep-value principles.

The Power of Compounding

For the 33 years ended 12/31/88, Walter J. Schloss Associates earned a compound annual return of
21.6% per year on equity capital vs. 9.8% per year for the S&P 500 during the same period. Buffett in
comparison returned 23% per annum for the 24 years to 1988. As covered in part two, Schloss was
under no illusion, he was not Buffett, and surprisingly, even though his returns were only 1.4% per
annum lower than those of Buffett over two decades, Walter Schloss didnt try to mimic Buffett, change
his strategy, or really do anything out of the ordinary.
In fact, Schloss made it clear to investors that he wasnt Buffett. Instead, as I covered in part two of this
series, Walter Schloss made it clear that over time, while his returns may not be earth shattering, the
power of compounding would accelerate returns over the long-term.

Peter Lynch visited literally thousands of companies and did a superb job in his
picking. I never felt that we could do this kind of worktherefore, went with a more
passive approach to investing which may not be as profitable but if practiced long
enough would allow the compounding to offset the fellow who was running around
visiting managements

And when you compare the returns of Walter Schloss, Buffett and Munger over the period 1962, to
1975, you can see that even though Schloss returns were erratic, (significantly more so than Buffett)
the power of compounding over the period was the driving force behind Walter Schloss' performance.
Thanks to ValueInvestingWorld and this ValueWalk author for the chart below.
And here are Walter Schloss' returns vs
the S&P 500 from inception through to
2000. Another scenario where
compounding shines through.

However, Schloss' returns were not powered by compounding in the traditional sense. Indeed, Schloss'
fund actually returned a huge amount of cash to investors every year, [screenshot showing the
distributions made throughout the life of the Schloss partnership] unlike Buffett and these distributions
had not been made, it's likely that Schloss' returns would have been even greater than those reported
above.
Still, even though Schloss' returns were not driven by compounding in the traditional sense, his
outperformance over the years is down to the fact that he knew steady growth over time and not losing
money, were the two keys to long-term success. As quoted above, Schloss called this the
compounding effect.

It's No Secret
The power of compounding is no secret. Indeed, the power of compounding was said to be deemed the
eighth wonder of the world but there are still plenty of investors, both institutional and private that fail to
make use of this carefree method of wealth creation. Indeed, respected value investors such as Seth
Klarman and Charles Brandes have recently noted that the market is now focused on short-term
performance only, failing to recognize the long-term benefits of compounding or growth.
Hedge Funds, mutual funds and private investors still try and outperform the market on a quarter-byquarter basis and this is where many investors could learn from Schloss. Walter Schloss understood
that he would never be the worlds best investor; he would never be able to consistently outperform the
market. Therefore, Schloss stuck to what he knew and understood, only buying stocks, which
conformed to deep-value criteria. The rest he left to the power of compounding.
That's all for part three but stay tuned for part four, Walter Schloss' 16 Factors Needed to Make Money
in the Market.
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