Bruce Greenwald: Averaging Down, Plus Selling On the Way Up, Drives Returns for Sonkin and Schloss

In a 2004 interview, Bruce Greenwald, Columbia business professor and value investing expert, spoke about micro-cap investor Paul Sonkin. Value investors continue to track Sonkin because of his excellent reputation and track record. During the 4 1/2-year period preceding the interview, Greenwald points out that Sonkin generated average annual returns of 25% compared to 3% for the general stock market.

What is fascinating is that Greenwald points out that the vast majority of Sonkin’s returns came from buying additional stock if an investment declined after the initial purchase. Greenwald explains that for this to work, an investor needs to have a great deal of confidence in his valuation methodology. Other prominent value investors have also advised buying additional shares if a security declines after your initial purchase.

The key here is knowing what you are doing. Greenwald also states that, in the case of Sonkin and Walter Schloss, their investing process included selling a portion of their shares on the way up. Of course, if you do not have a robust valuation methodology or simply bought shares because a given security was going up in price and you figured you could offload them to someone else at a higher price, this strategy is unlikely to work. You’re more likely to do just the opposite and dump your shares out of fear if your position moves against you.

Investing like Sonkin and Schloss also requires only investing when you have a margin of safety.

Here the relevant part of the interview:

Greenwald: . . . And the third thing you have to have is discipline and patience. In the story I’m going to tell you about discipline and patience and the value strategy is about Paul Sonkin — his name is on the book — who was put into business by a set of value investors, myself among others. He’s just performed phenomenally. He’s been in four and a half years, and you can’t really tell on a four-and-a-half-year record, but his returns after fees have averaged about 25% with a market around 3.

TMF: That’s incredible.

Greenwald: He has a strategy of very, very small stocks. So if he buys half a million dollars, then he has to file a 13D [required when you buy more than 5% of a company’s stock] in some of these companies. But that means he’s the only one there. So he satisfies the first criteria. He’s got the basic valuation methodology. But one of the things we did in looking at his trades is that we looked at what he would have made if, when he made the first purchase of the stock — the first time he bought it — he just bought it there and he’d sold it at the first sales. So that he’d just done one buy decision and one sell decision, as opposed to buying it first, finding out, oops, the stock has continued to go down, but continuing to buy on the down side, having confidence in your valuation judgment. Of the 25% return, about 22% of it came from purchases at lower prices than the initial purchase. We’ve got Walter Schloss’s archives, and it looks like — we haven’t got the numbers yet — a large percentage of Walter Schloss’s returns have come also over time from knowing that you’re buying something worth buying. And then when it goes down, not getting frightened and dumping it, but continuing to buy. And then selling on the way up. Looks like that does a lot better than just averaging down. [emphasis added]

TMF: I recently spoke with Mary Chris Gay, who is Bill Miller’s colleague. That’s their strategy, she said: Lowest average cost wins. I suppose that’s confirmed now.

Greenwald: That’s exactly right. But notice what that depends on. You have to have confidence in your valuation. And you have to have the discipline to stick with it, that if this is a good stock and nothing has changed about the underlying value of the company, then if it’s a good stock at 8, then it’s a better stock at 4, rather than people who will see a stock go from 8 to 4 and say, “Oh crap, something’s going on here that I don’t know about.”

TMF: And there are a lot of people who think like that.

Greenwald: Who would think that and dump the stock.

Here’s the interview in its entirety.

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2 thoughts on “Bruce Greenwald: Averaging Down, Plus Selling On the Way Up, Drives Returns for Sonkin and Schloss

  1. Pingback: More Thoughts on Small Cap Investing | GregSpeicher

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