Can you tell us a little bit about your background? I started in the financial services industry while I was still in college, and have been in it ever since. After Hurricane Andrew in 1992 I started studying derivatives and liked it so I began trading. I was taught to trade by a student of the one of the traders profiled in the popular book Market Wizards so I knew what I was doing; nevertheless, I got taken out 5 years later during the Asian Contagion. That experience led me to Graham & Dodd, and to risk management. I am now consulting on M&A using Graham & Dodd valuation and, incredible as it may seem, as far as I know I am the first person to do so.
You worked in risk management. From your perspective what is risk? Beta? Standard deviation? Something else? As Ben Graham said, risk is “a loss of value which either is realized through actual sale, or is caused by a significant deterioration in the company’s position–or, more frequently perhaps, is the result of the payment of an excessive price in relation to the intrinsic worth of the security.” (Benjamin Graham, The Intelligent Investor (NY: Harper, 1973), p. 61).
How has your risk management background affected your development as an investor and philosophy of investment? I am a bottom-up financial analyst so I use the same skills in risk analysis that I use in valuation; in other words, I seek to identify risk drivers in much the same way that as a Graham & Dodd analyst I seek to identify value drivers. I then look for economical ways to mitigate risk. This may sound easy, but I assure you it is not: good risk managers are as rare as good investors.
What inspired you to write the book? I was publishing a lot of case studies, and based on the feedback I was getting felt they would make a good book; however, I never had the time to sit down and write one. My dad then got very sick, and I felt if I was ever going to write a book I wanted him to see it so I rushed to finish it.
Not to flatter, but hundreds of books have been written about value investing. Your book has received praise from many people, why do you think that is? I have received a great deal of positive feedback from professional investors and M&A specialists. They like the book for the same reason why I wrote it: there are a lot of great books on investment philosophy, but there aren’t any that show, step-by-step, how a significant investment can be valued. Furthermore, my book focuses on M&A, and for whatever reason that area has not embraced Graham & Dodd like the investment community has. Hopefully, my book will help to change that.
Your book received endorsements from Seth Klarman, Mario Gabelli and Mitch Julis among others. How did you come to know investors of this caliber? Mario Gabelli spoke in a class I taught at the University of Connecticut. I met Mitch Julis after he read a paper I published, and my editor at McGraw-Hill introduced me to Seth: they had just finished the magnificent 6th edition of Security Analysis, which I reviewed for Strategy & Leadership. The journal editor wanted the review to include an interview, which I conducted.
You talk about Warren Buffett’s purchase of GEICO in your book. You also will be talking about that topic at the upcoming NYSSA event, can you elaborate? The GEICO case offers a great many lessons that can be practically leveraged. In the presentation I am going to demonstrate that by comparing a Graham & Dodd valuation of GEICO to a more mainstream-based valuation, and then I am going to show how Graham & Dodd can be used to mitigate the risk of common valuation errors.
Your book is an addition to the principles of Graham and Dodd, can you elaborate? I extend modern Graham & Dodd theory in a variety of ways; for example, I coined the term “base case value” to reflect the relatively common pattern of net asset value being relatively equal to earnings power value. This pattern occurs often, but it can be very profitable when it offers a reasonable margin of safety.
I also leveraged Graham & Dodd insights from a macroeconomic perspective, which a number of hedge funds have latched onto. (For more information see the question immediately below.)
I also showed how Graham & Dodd concepts can be used to value super catastrophes. This chapter generated a great deal of email from quants–including physicists who sent me heavily mathematical treatments of the topic, many of which I was barely able to understand. The point of my chapter was to show that you did not need deep mathematics to value things like super catastrophes; rather, you could arrive at a sound valuation using sound valuation techniques such as Graham & Dodd-based techniques.
Finally, I leveraged Graham & Dodd thinking in a managerial context by profiling how valuation can be used for value realization purposes. My next book will likely get into this topic much more.
You talk about George Soros and the eight stages of a business cycle can you elaborate? Given the state of the economy, investors need a macroeconomic analytical framework. When I was trading I studied Soros’ writings, and I came to like his boom-bust model as it captured what I experienced as a trader. So I added fundamental and behavioral criteria to that model to show how it could be used in a macroeconomic context to screen for investment leads. As indicated above, this chapter in particular has generated a great deal of interest from the hedge fund community
On the macro-level, you are a big believer in Austrian economics; does this affect your investing style? First of all it is important to note that, while I do publish academically and teach at a university I am not a professional academic: I am a practitioner. Therefore, as a practitioner I am always on the look-out for theories that can help me, and my clients, either make money or avoid losses.
I literally stumbled over Austrian Economics while I was researching the causes of my failure as a trader during the Asian Contagion. The thing that impressed me about Austrian Economists is how often they have been right: from their 1920 call that communism was not sustainable to all their business cycle calls. Given that track record, I studied it and I incorporate Austrian insights into my work. More-and-more financial professionals are also doing so.
To purchase the book on Amazon.com, click on the following link- Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffett’s Valuation Principles to Acquisitions, Catastrophe Pricing and Business Execution.
Joseph Calandro, Jr. has published widely across disciplines in a variety of journals including the Journal or Private Equity, Journal of Alternative Investments, Strategy & Leadership, others, and he has presented papers at conferences held in the United States, United Kingdom, and Canada. He is a finance department member at the University of Connecticut and recently joined PwC as a managing director in the firm’s insurance consulting practice. The views he expresses in this interview are his own, and not necessarily those of PwC.
Some of Joe’s academic papers are available for download at The Social Science Research Network author’s page, his book can be found at the following link- Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffett’s Valuation Principles to Acquisitions, Catastrophe Pricing and Business Execution.