Tuesday, November 28, 2006

Journey into the Whirlwind-Louis Lowenstein

Louis Lowenstein is the Rifkind Professor Emeritus of Finance and Law at Columbia University, a former CEO, a former corporate director and the author of "Sense and Nonsense in Corporate Finance" as well as "What's Wrong with Wall Street-Short Term Gain and the Absentee Shareholder" both excellent books. Another notable accomplishment...he is the father of Roger Lowenstein, one of the great business writers and in my view, the author of the best of the Buffett biographies. Both father and son are fixtures at the Berkshire annual (and I suspect long time shareholders.)

Louis Lowenstein is an enemy of that socially destructive addiction called trading. Columbia has published a speech he delivered about a year ago before the NY Society of Security Analysts which celebrated Value Investing and Irving Kahn's 100th birthday.

Here is a link to that fabulous speech.

A few highlights to whet your appetite! Lowenstein refers to the large majority of all equity funds that are managed "energetically so as to keep pace with the market." He tracks the record of the twenty largest large cap growth funds circa 1997 which due to mergers and style drift numbered fifteen survivors. These fifteen underperformed ten value funds (selected by Bob Goldfarb of Sequoia and Ruane Cuniff fame) by 18% per year. As Lowenstein describes it, "With a good tailwind, those large cap funds were not so great- underperforming the index by almost 2% per year-and in stormy weather their boats leaked badly."

He mocks the "senseless trading" that occurred in one mutual fund which will go nameless here...it is named in the article. Turnover at one point hits 305%. Of note,the fund's "investors" were just as bad...merely speculators who were trying to catch the next new thing. One year "investors" redeemed $17.5 billion in mutual fund assets and bought $16 billion in new shares, leaving the fund at year end with $14 billion. Clearly, management got the shareholders they deserved!

He later provides one of the great lines:

"While our large growth funds demonstrate that an investor can do worse than indexing, it remains true that an intelligent investor can do better."

Later in the speech, he focuses on Graham and Doddsville. He describes CAPM and other formulae as "an effort to reduce uncertainty to a quantifiable risk" but as he eloquently quotes von Hayek:

"They are measuring what is measurable, not what matters."

He quotes Bill Ruane's "Memorandum of Investment Philosophy" with five principles:

  1. Buy good businesses. The single most important indicator is a superior return on capital, because it means the company enjoys a unique proprietary position.
  2. Buy businesses with pricing flexibility, always true, but particularly in the inflationary period in which he wrote.
  3. Buy stocks at modest prices. While price risk cannot be eliminated, it can be lessedned materially by avoiding high multiples.
  4. Buy strong balance sheets, If this rule is violated, none of the others will matter!
  5. Buy cash generating businesses, those where the earnings are truly available to create future growth or for payment to stockholders.
He finally points out that if you are fretting that the VIX may be signaling fear this week, value investing is not for you!

This is truly a worthwhile read and a great reminder of the disciplines that are required for both value managers and their investors.

Disclaimer: I, my family, and clients proudly own a current position in Berkshire Hathaway.


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