Marty Whitman’s Brutal Critique Of Greenwald’s Value Investing Book

Marty Whitman’s Brutal Critique Of Greenwald’s Value Investing Book

by csinvestingNovember 11, 2013

A reader, the Great Sandesh, alerted me to this. By the way, I am not a fan of Prof. Greenwald’s book,Value Investing — From Graham to Buffett and Beyond written by Bruce C.N. Greenwald, Judd Kahn, Paul D. Sonkin and Michael van Biema. But I do highly recommend his book, Competition Demystified,to learn  strategic analysis. Whitman discusses the book in his 2001 TAVF Shareholder Letter. The language used by all academics, including Greenwald, et al, that securities values are a function of the present worth of “cash flows” is unfortunate. From the point of view of any security holder, that holder is seeking a “cash bailout”, not a “cash flow”. One really cannot understand securities’ values unless one is also aware of the three sources of cash bailouts.A security (with the minor exception of hybrids such as convertibles) has to represent either a promise by the issuer to pay a holder cash, sooner or later; or ownership. A legally enforceable promise to pay is a credit instrument. Ownership is mostly represented by common stock.

There are three sources from which a security holder can get a cash bailout. The first mostly involves holding performing loans; the second and third mostly involve owners as well as holders of distressed credits.

1. Payments by the company in the form of interest or dividends, repayment of principal (or share repurchases), or payment of a premium. Insofar as TAVF seeks income exclusively, it restricts its investments to corporate AAA’s, or U.S. Treasuries and other U.S. government guaranteed debt issues.

2. Sale to a market. There are myriad markets, not just the New York Stock Exchange or NASDAQ. There are takeover markets, Merger and Acquisition (“M&A”) markets, Leveraged Buyout (“LBO”) markets and reorganization of distressed companies markets. Historically, most of TAVF’s exits from investments have been to these other markets, especially LBO, takeover and M&A markets.

3. Control. TAVF is an outside passive minority investor that does not seek control of companies, even though we try to be highly influential in the reorganization process when dealing with the credit instruments of troubled companies.

It is likely that a majority of funds involved in value investing are in the hands of control investors such as Warren Buffett at Berkshire Hathaway, the various LBO firms and many venture capitalists. Unlike TAVF, many control investors do not need a market-out because they obtain cash bailouts, at least in part, from home office charges, tax treaties, salaries, fees and perks.

I am continually amazed by how little appreciation there is by government authorities in both the U.S. and Japan that non-control ownership of securities which do not pay cash dividends is of little or no value to an owner unless that owner obtains opportunities to sell to a market. Indeed, I have been convinced for many years now that Japan will be unable to solve the problem of bad loans held by banks unless a substantial portion of these loans are converted to ownership, and the banks are given opportunities for cash bailouts by sales of these ownership positions to a market.

Greenwald, et al have a monolithic approach to analysis using three tools to analyze all companies — replacement cost of assets, earnings power, and franchise value. TAVF, on the other hand, analyzes different businesses differently, ranging from analyzing strict going concerns by giving heavy weight to earnings power, as for example AVX or Nabors; to analyzing businesses which are really investment companies masquerading as something else. Here, heavy weight is assigned to readily measurable asset values as well as an appraisal of managements’ abilities to increase these net asset values over the long-term. Catellus, Forest City, Hutchison Whampoa, Investor AB, and Toyota Industries are examples of such situations.

Greenwald, et al, like almost all academics, consciously or unconsciously, look at companies as substantively consolidated with shareholders. This tends to be a non-productive approach almost all the time. At the Fund, companies are analyzed as stand-alones or parent-subsidiary. The common stock for TAVF is a different constituency from the company, or its management — separate and apart.

Most academics pay much attention to an artificial calculation: — the Weighted Average Cost of Capital (“WACC”). WACC measures the cost of outside capital to a company as a blend of after-tax interest rates and capitalization values for common stocks based on references to current common stock prices in public markets. Interest is, of course, a cash cost, while capitalization rates for publicly traded common stocks have nothing to do with most companies since they do the bulk of their equity financing by retaining earnings rather than by selling new issues of common stock to the public. More importantly, though, WACC is not very meaningful for companies who have rather complete control of the timing as to when, or if, to access capital markets. Such companies will access outside sources of capital at the time WACC type pricing is most attractive to them. These are the companies in whose common stocks TAVF invests. A contemporaneous calculation of WACC for these companies tends to be not meaningful.

Via csinvesting