Found the following article on capitalideasonline (bold emphasis and italic comments are mine)

In an investment classic “Greatest Investing Stories”, there is a brilliant piece on Martin Whitman.

“We don’t carry a lot of excess baggage,” he says in the flatted vowels of his native Bronx. “A lot of what Wall Street does has nothing to do with the underlying value of a business. We deal in probabilities, not predictions.”

“The record entitles him to argue that “There are only two kinds of passive investing, value investing and speculative excess.” For the last two years, like 1928-1929 and 1972-1972,” continues Whitman, “we’ve had nothing but speculative excess.”

“These days, argues Whitman, management has to be appraised not only as operators of a going business, “but also as investors engaged in employing and redeploying assets.”

“As a long-term investor looking to a number of possible exit strategies, Whitman glories in the freedom to ignore near-term earnings predictions and results. Acidly, he argues that Wall Street spends far too much time “making predictions about unpredictable things.”

“His search is for companies backed by strong financials that will keep them going through hard times (“safe”), selling at a substantial discount below private business or takeover value (“cheap”). Buying quality assets cheap almost invariably means that the company’s near-term results are rocky enough to have turned off Wall Street. “Markets are too efficient for me to hope that I’d be able to get high-quality resources without the trade-off the near-term outlook not being great,” says Whitman. He chuckles and runs a hand through a fringe of white hair. “When the outlook stinks, you may not have to pay to play.”

“It’s a lot better than being called an indexer or an asset allocator,” he says, taking another poke at standard Wall Street dogma.”

“Whitman’s job is to sniff out what is wrong, and figure out the trade-offs against what is right, particularly in terms of some form of potential asset conversion.”

“Among the most common wrongs Whitman tries to avoid:

a) Attractive-seeming highly liquid cash positions that on inspection prove to be in the custody of managements too timid to put surplus assets to good use;
b) Seductively high rates of return on equity that often signal a relatively small asset base;
c) A combination of low returns on equity and high net asset value that may simply mean that asset values are overstated;
d) High net asset values that may point to a potentially sizable increase in earnings, but which just as often point to swollen over-head.

I have seen point b come up in several of my stock screens. Based purely on the screen, the company looks attractive. Digging deeper show some asset write offs which has artifically raised the return on equity.kind of highlights the risk of relying blindly on stock screen (I never do that though, generally using them to generate a finite list of companies to look at deeper)

“Whitman’s willingness to take on companies like the stereotypical “sick, lame, and lazy” he treated as a pharmacist’s mate – the old salt, in Navy slang, still thinks of himself as having been a “pecker checker” – is not unalloyed. Buying seeming trouble at a discount, Whitman ignores market risk (current price swings). Whitman worries all the time, though, about investment risk (the possibility he may have mis-judged a temporary illness that will prove terminal).”

“As smallish niche producers, often protected by proprietary tech­niques, the equipment manufacturers seemed less vulnerable to shake out, and had better “quality” assets. Unlike the far more capital-intensive chip makers, with their heavy investments in bricks and mortar, the equipment producers operate out of comparatively low-cost clean rooms, and buy, rather than make, most of their components. Research and development costs are high, but Whitman cannily focused on com­panies that expensed rather than capitalized them. Those running charges understated earnings, making them seem particularly weak in the down cycle. So much the worse for Wall Street.”

“Whitman continued to buy a cross section of equipment producers at quotes he regarded as “better than even first stage venture capitalists have to pay, and for companies already public and very, very cash rich.”

“Whitman was averaging down, a key part of his strategy, but anathema to Wall Street’s momentum players.”

Should be done only if one is sure of what he is doing and has strong reasons to believe that the market is wrong ( ‘I feel the stock will do better’ does not quality)

“Most,” he thought, “ought to do okay and a few ought to be huge winners, but there would be a few strikeouts.” The exit strategy for the strikeouts, in a consolidating industry, would almost certainly be acquisition.”

“Beyond diversification, Whitman protected himself by loading up on management that fit his two acid tests: good at day-to-day operations and equally good as asset managers.”

“Once again scoffing at market risk, Whitman underlines the com­forts of being cushioned by strong financials. “When you’re in well­-capitalized companies, if they do start to dissipate, you get a chance to get out.” “On the other hand,” he continues, “when you’re in poorly cap­italized companies, you better watch the quarterly reports very closely.”

“That’s because he thinks in terms of multiple markets. What may seem to be a very rich price to an individual investor can be a perfectly reasonable one for control buyers looking to an acquisition. They can afford to stump up a premium because of the advantages control brings. Among them is the ability to finance a deal on easy terms with what Whitman calls “OPM” (Other People’s Money) and “SOTT” (Something Off The Top) in the form of handsome salaries, options, and other good­ies that come with general access to the corporate treasury.”

Read the book ‘Value Investing : A Balanced Approach’ for a better understanding of multiple market referred to by martin whitman.

“Shop depressed industries for strong financials going cheap and hang on. By strong financials Whitman means companies with little or no debt and plenty of cash. What’s cheap? No hard and fast rules. “Low prices in terms of the resources you get,” he generalizes.”

“Some of his other pricing rules of thumb:

a) For small cap, high-tech companies, a premium of no more than 60 percent over book – about what venture capitalists would pay on a first stage investment.
b) For banks, Whitman’s limit is no more than 80 percent of book value.
c) For money managers, Whitman looks to assets under management (pay no more than two percent to three percent).
d) For real estate companies, he zeros in on discounted appraised values rather than book.”

Good reference point to look at when doing your own valuations for any of these type of companies

“Whitman, thumbing his nose at convention, has clearly established himself as an outside force on Wall Street. Despite the philosophical linkage, he even backs off from identification with what he calls Graham & Dodd Fundamentalists. The basic similarities are striking: long-term horizons, a rigorous analytic approach to the meaning behind reported numbers, and an unshakeable belief that probabilities favor those who buy quality at the lowest possible price. Like Ben Graham, Whitman scoffs at the academicians who hold that stock prices are set by a truly knowledgeable and efficient market. Acknowledging his debt to Graham, Whitman argues that his calculated exploitation of exit strategies has added a new dimension to value investing.”

“Whitman says, “I couldn’t be a trader. I’m very slow with numbers. I have to understand what they mean.”

“It’s the art of the possible,” he says. “The aim is not to maximize profits, but to be consistent at low risk. I never mind leaving something on the table.”

“Whitman, look to a credit against the probability of a default. He looks beyond the credit to see what can be got when it does default-yet another variant on “safe and cheap.”

“Whitman backs this contention with a notably unsentimental view of how Wall Street really works. He argues that heavy reliance on short-­term earnings predictions as the key to market values makes trend play­ers of money managers. Such linkages are the stuff of stock market columns. The Genesco shoe chain allows that fourth quarter earnings will “meet or exceed” analysts’ estimates, and the stock pops with a gain of almost 25 percent. Sykes Enterprises, a call-center specialist, signals that earnings will be down, and the stock falls by a third.”

“Making forecasts about future general market levels,” writes Whitman in Value Investing, “is much more in the realm of abnormal psychology than finance.”

“Analysts who focus on earnings trends to the exclusion of asset val­ues, continues Whitman, tend to think laterally. “The past is prologue; therefore, past growth will continue into the future, or even accelerate.” Unfortunately, the “corporate world is rarely linear,” and becomes a particularly dangerous place for trend players who leave no ‘margin of safety in concentrating on high multiple growth stocks.”

“A bargain that stays a bargain isn’t a bargain.”

I think he is refering to a value trap. A company which stays cheap forever either due to poor management or because the intrinsic value is shrinking

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