Should you buy a firms's asset or earnings ?

He has never possessed a computer and gets all his prices from the morning newspaper. Further, most of the financial data he wants is delivered to him by mail. Well, this statement does look straight from the 60s and 70s, isn't it? However, this is exactly how a gentleman named Walter Schloss used to invest till over a year back until he passed away. And how did he do with his investing? Well, he knocked the daylights out of market indices over a career spanning nearly 50 years. Little wonder, Warren Buffett used to refer to him as the super investor. 

These were not his only quirks though. In fact, we believe that his biggest quirk had to do with the way he used to pick his stocks. As per him, one of the most important factors to make money in the stock market is buying assets at a discount rather than earnings! 

Well, in a world loaded with PE investors and sophisticated DCF calculations, here is a super successful investor who is actually recommending valuing companies based on assets rather than earnings. Thus, it's important that some light be shed on this anomaly. As per Schloss, earnings can change dramatically in a short time but assets change slowly. Also, one has to know much more about a company if one buys earnings, he further added. 

What this tells us is that Schloss had an absolutely first rate understanding about his circle of competence. And although its size would have been small, he knew exactly where its boundaries lay. You see, Schloss never tried to understand a company's operations intimately. Infact, he stayed totally away from managements too. Consequently, he did not invest in stocks under the assumptions that its earnings would rise. 

Buying assets however does not require one to know which way earnings would go. The idea here is to buy at a significant discount to market value of assets and then to hope that over time, the gap between price and value is filled up. Earnings just don't come into the picture here. If they go up, well and good, but the entry price is not based on the same. 

What investors can learn from people like Schloss and for that matter even Buffett is the art of knowing one's circle of competence extremely well. There are companies out there that lend themselves to both kinds of valuation i.e. asset based and earnings based. However what matters is how well do we know them so that we can arrive at a proper intrinsic value calculation of the stock. Understanding this one crucial factor can make a world of difference to one's investing track record we believe. 

Source:
Equity Master