Investment Insider

Marty Whitman on buying value

Few Wall Street veterans are as talented and outspoken as this fund manager. Here's how he chooses winning investments.

As a kid growing up in the Bronx during the Depression, Marty Whitman learned the value of a buck. And it shows in the way he runs his $2.2 billion mutual fund, Third Avenue Value. Whitman is careful not to overpay for good investments, and he typically holds them for years, which reduces his shareholders' exposure to capital gains taxes. Although it had a rocky 2002, Third Avenue Value's 10-year average annualized return is a superior 11.6 percent through July. That's more than a percentage point better than the return of the S&P 500 over the same span.

At 78, Whitman shows few signs of slowing down. In addition to managing Third Avenue Value, he teaches a finance class at the Yale School of Management two days a week.

Unlike many of his colleagues in the investment business, Whitman dresses casually at work and doesn't sweat the stock market's daily fluctuations. Remember Oct. 19, 1987, better known as "Black Monday"? Whitman wasn't even aware that the market had crashed until someone brought it to his attention the next day.

In his new office with a breathtaking view of midtown Manhattan, Whitman sat down for a conversation with Medical Economics Senior Editor Dennis Murray.

You buy stocks that you've termed "safe" and "cheap," and hold onto them for long periods. Sounds like a simple strategy. Why aren't more individual investors and mutual fund managers following it?

Very few people do it because it's easier to speculate in the market than to do the hard work of reading and understanding financial statements and other documents that indicate whether a stock is priced fairly.

Define safe and cheap.

A "safe" common stock is one issued by a company that has three characteristics: One, it has an exceptionally strong financial position, as measured by a relative absence of liability, high-quality assets comparable to cash, or that rarity, free cash flow from operations. Two, it has strong management. And, three, it's forthright about what it does and how it makes money.

"Cheap" means buying in at no more than 50 cents on the dollar, based on what we think the stock would be worth if the company was a takeover candidate.

Wow. That is cheap.

Yeah, based on our definition, we don't find too many cheap stocks, unless the near-term outlook for them is lousy.

What stocks are you excited about?

We've owned Toyota Industries for many years. It's a way to buy into Toyota Motor common stock at a huge discount. Toyota Industries is a wonderful company—extremely well-financed and with first-rate operations. It manufactures parts, and builds cars and industrial vehicles.

We also own several little-known real estate companies that meet our criteria for safe and cheap. Among them are Forest City Enterprises, The St. Joe Company, and Tejon Ranch. The St. Joe Company, for instance, is the largest private landowner in Florida, where it owns almost a million acres. But few investors talk about it.

Not everything in the fund is both safe and cheap. Case in point: Kmart. While the company is emerging from bankruptcy, it's far from out of the woods.

I agree, but Kmart's now debt-free, with something like $700 million in cash and a substantial amount of attractive real estate. Whether it will come all the way back depends on three things: management, management, management. I like the new people who are running the company.

Management is notoriously tough to evaluate. How do you do it?

We first go through all of the documentary disclosures. We look at how the company has performed, how the executives are compensated, what kind of insider transactions they've been involved in, how they keep their books—are they conservative or are they gunslingers? There's always something material to examine. It's more than just visiting management and getting stroked by them. It's a combination of intensive study and talking to the people in charge.

How willing are you to search other countries to find good buys? Do political turmoil and fluctuating currencies scare you?

We'll look overseas, but only at blue-chip stocks from industrial countries. Sure, the possibility of political instability makes me nervous. But it's something I can't control, so it's not even on my radar.

Does your approach to buying bonds differ from how you evaluate stocks?

No. We look at the company the same way. If we determine that it has a strong financial position, we'll buy the common stock and hold it for as long as it makes sense. If it doesn't have a strong balance sheet, we'll only be a creditor. That helps to limit our risk on the downside, because bondholders generally get paid before holders of common stock in bankruptcy proceedings.

After the tech wreck in 2000 and the recent wave of Wall Street scandals, did you change the way you look at a company?

No. The people who run the companies in our portfolio are very conservative—plainspoken, Midwestern-type folks. And one of the good things about buying the stock of companies with super-strong financial positions is that they're not dependent on Wall Street.

Meaning?

They don't need Wall Street to help them raise money from the sale of common stock.

What about companies that aren't as strong financially? Can investors trust the numbers they report?

The problem isn't with the accounting, which involves objective financial benchmarks. The problem is with the people who use the accounting, because they're unwilling or unable to interpret it properly. That goes for the vast majority of analysts, who, increasingly, are determining what financial disclosures really ought to be. These are the inmates who seem to be running the asylum. It's ludicrous.

Did anything change for the better after the scandals?

Yes. There's more public disclosure than there has ever been. I serve on the audit committees for two public companies, and we're doing everything we can to make the disclosures more complete, to help the companies avoid lawsuits from aggrieved investors. The financial statements have to be consistent and include everything that might be material.

That's interesting, because you've said that having CEOs and CFOs certify the accuracy of their financial statements could actually be harmful. What did you mean?

There's no way reported numbers are going to be really truthful and accurate in all contexts, no matter how many executives say they are. Having CEOs and CFOs swear to the truth and accuracy of financial statements seems certain to give the plaintiffs' bar more incentive to pursue frivolous lawsuits than to take meaningful action against real wrongdoing by corporate insiders.

You've been outspoken about Boards of Directors that seem to exist only to enhance the wealth of executives. Has that always been the tendency? Can it be fixed?

There has been a 30-year trend toward the abdication of shareholders' rights. Shareholders have been giving them to management. That trend accelerated in the 1970s and 1980s. Obviously, as a stockholder myself, I'd like more rights for shareholders, but I'm not holding my breath. The SEC has no jurisdiction over corporate governance. Any sort of relief would have to come from the New York Stock Exchange or the Nasdaq, either of which, as a self-regulatory organization, could refuse to list the common stocks of companies that permit management entrenchment. But I don't see that happening any time soon. Deep down, I don't think that they're really interested in doing anything that would offend management.

You're 78 years old, working in a difficult, stressful business. Do you have plans to retire any time soon?

I like my work. I can't be a tennis pro. What else am I going to do?

 

Dennis Murray. Investment Insider: Marty Whitman on buying value. Medical Economics Sep. 19, 2003;80:33.