A discussion with Professor Bruce Greenwald

I have come across the interview of Bruce Greenwald on Columbia Business School website on The Past, Present, and Future of Value Investing. Professor Bruce Greenwald is the author of many well-respected books on value investing like “Value Investing: From Graham to Buffett and Beyond“, “COMPETITION DEMYSTIFIED: A Radically Simplified Approach to Business Strategy“. He is also the co-director of the Heilbrunn Center for Graham & Dodd. The New York Times described him as “a guru to Wall Street’s gurus,”

It is a relatively long interview (one and half hour) but is packed with value investing pearls of wisdom. As the name of the topic suggests, it talks about how value investing has evolved over the year from Benjamin Graham to current high profile practitioner like Warren Buffett, Seth Klarman.

http://www8.gsb.columbia.edu/centennial/value-investing-live

I spent few hours going back and forth and taking notes. I strongly recommend watching the video. Here is my key take always from the talk.

    • Everybody loves the winner. The idea of latching on to the winner and making money is exciting. A lottery has been the great enterprise but it is a bad investment.
    • People do not want to concentrate on ugly, bad and unpleasant. Something they do not like, they dump it.
    •  People are much more certain that what is going in reality.
    • If you find a great bargain, you have to ask yourself why God has given you an opportunity and bargain? Why is the stock failing?When you find an opportunity, you have to find how much it is worth.
    • On asset and Benjamin Graham- – Benjamin Graham believed that if you want to grow, you have to have an asset. Earlier assets were important, and nowadays they are not as important. What Benjamin Graham missed that you could make money if you/company has an economic position that keeps out the competition. Warren Buffett calls it as a Franchise Business.
    • Warren Buffett understood early on economic of industries around Omaha. Wachovia was the largest lender to the tobacco farmer, and it was profitable. They know Nitti grittiest of the industry. Some European bank got attracted to the opportunity and offered attractive rate to farmers. Wachovia matched the rate for some customer but did not extend the credit to the doubtful creditor. European Bank happily extended the credit to these questionable borrowers to gain market share and ended up with 90% of the NPA when the crisis came.
    • Economic of a daily newspaper- Newspaper has a high fixed cost, distribution cost and not very profitable. If another company enters, it will be very hard for it to make money. In case the market is adequate for one player, no new player will enter. As a result, existing player will get economic of scale, profit and they will grow.
    • Good management is already discounted in stock prices. Looking at the regression to mean, it has only one-way, and it’s it go down.
    • Growth for the sake of growth destroys enormous value. Companies have to earn the return above the cost of capital to create value.
    • Security Analysis /Intelligent Analysis did not do microanalysis of the companies. They relied on accounting numbers.
    • Everybody in the world is thought to value companies by DCF. In theory, the could be the right thing, but in practice, it is the stupidest thing because
      • It Ignores the balance sheet entirely.
      • Take near term cash flow.
      • Plus log of assumption about other factors (discount rate
      • Rely too much on future projections.
    • In a growth company, it is necessary the case that lot of value is way out in future. So it is incredibly hard to value a growth company. Benjamin Graham understood the math & he kept away from the growth companies.
    • Seth Klarman, Warren Buffet – If they are given a price at which to buy a stock today, they say, if I but at this prices, I am likely to get a return in the range of X to Y. They do not try to access value far in future.
    • [44:00]Once of the great feature of the value investor is, they do not try and see changes in future. They look at what is there today and they look at stability
    • [46:00] Nestle Valuations- Nestle has a dominant position in Pet food, coffee, dairy products, food, prepared food, confectionaries and many other segments. It is an incredibly stable business in good and bad times.

In 2003, when the prices of input rose, it passed on the price and maintained it’s margin. Last year (I assume 2015) earnings were 12 billion Swiss francs. In the worst case, it may go down to 12 billion Swiss francs. Here are the maths if someone buys the Nestle in full.

Full Acquisition Cost

Full Acquisition Cost

Note the logic and calculation used in thinking. One can buy a full control of Nestle by taking a loan of 300 billion Swiss Francs (on loan) and get 10 billion Swiss Francs of immediate earning (16 billion earning of 2016 – 6 billion towards interest payment) with increasing earning in future.

    • When you are talking about understanding fundamentals, specialisation matters a lot.
    • [1:01:00]- your automatic instincts are instincts of everybody else. 95% people want to buy get rich in stock.
      95% of people will not think of a stock which has 2/3 chances of bankruptcy despite the fact that if it does not go bankrupt, it will go six-fold.
    • You can avoid this basic human instinct by following disciplined quantitative strategy.
      Value investor needs to specialise in the particular area. You have to follow 2/3/4 industries that you really know. If you try to do everything, you will not be on the right side of the transaction.
    • Benjamin Graham thought of asset are required to generating revenue. Dominant position in the market can also create value without many assets (evolved thinking about value investing). To have this- the company need to be dominant in the market, and it has to protect the position.
    • Two ways to look at cheap, ugly, obscure and out of favour.
      •  If you are looking for cheap, go ahead and buy companies on statistical bargain based on numbers
      • Look for industries you can learn about where bargain are going to be unrecognised,
        • Manufacturers like Jon Dee who have a lot of service component and which are susceptible to be monopolised, where people like still applying old cyclical like manufacturing like models.
        • People value companies on increasingly on earning forecast. There are companies where you cannot ignore earnings, but on the other hand, there are some important asset components. The one seems to be least understood in that area is insurance. Insurance you got a slug of assets like float, and you go operating the business as a negative cost of float. A lot of local companies in insurance space dominate monoline area in certain geography that is very profitable, but they are not earning any money on float because they are very conservative. If you move that money to somebody like Berkshire, who knows how to invest that float the values of these companies is likely to go up. So insurance is another area that is badly understood.
      • Another 100-year advice- “ I do not see human being changing much. Until Human develop third legs, my advice will is to stick with value perspective and specialise”.
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