Martin J. Whitman, the founder of Third Avenue Management, legendary investor and a pioneer value investor passed away this week at the age of 93. He leaves behind him one of the most outstanding value investing records in history as well as the Third Avenue brand.
“I think it’s easier than trying to play the market and forecast the market’s gyrations. Most investors are outlook-conscious. I’m price-conscious. I have this easy way of measuring price, quantity, and quality. Everything is in the balance sheet–the only way you know whether you’ve covered all the bases is to look at the balance sheet.” — Marty Whitman
Martin or Marty Whitman, founded the predecessor firm to Third Avenue Funds in 1986 and M.J. Whitman LLC, a full-service broker-dealer affiliated with Third Avenue Management, in 1974. He launched the Third Avenue Value Fund in November 1990 and managed it until 2012 when a new team took over after he retired.
Mr. Whitman's record at the Value Fund was outstanding. From inception in November 1990 through October 2007, the fund returned 16.83% annualized compared to a return of 12.33% for the S&P 500 over the same period.
Unfortunately, following the financial crisis the fund struggled to continue at its historic rate with returns falling to 8.8% annualized or 35.8% compounded compared to a total gain for the S&P 500 of 89.4% over the same period before Mr. Whitman stepped down in 2012.
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“Earnings are vastly overrated. Look at the title of my new book, Value Investing: A Balanced Approach (John Wiley & Sons). No smart businessman treats one accounting number as more important than another. They are all part of the whole. The goal of any business person is to create wealth, and except on Wall Street, profits are viewed as the least desirable way to create wealth because of the income-tax disadvantage. It’s a lot easier to look at the quantity and quality of resources a company has than to forecast its earnings. If you have good management, it will convert those resources into something of value.”
Mr. Whitman was a vocal critic of GAAP accounting standards and preferred instead to look to a company's balance sheet to find value. Rather than looking at earnings, he wanted to see book value growth -- a confirmation that a company is able to successfully reinvest its capital. In one letter to investors, Mr. Whitman highlights that fact that the first thing Warren Buffett discusses each year in his shareholder letter is Berkshire’s change in book value. He believed that most investors would benefit from concentrating more on a company's balance sheet, rather than trying to estimate future earnings power, which Wall Street tends to get caught up with.
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 was one authority Mr. Whitman disagree with on the earnings front. In his 2001 letter to shareholders of the Third Avenue Value Fund, he wrote "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.'" He goes on to say that there are three sources from which a security holder can get a cash bailout including 1) Dividends, 2) a sale or 3) control of the company, none of which the passive investor has control over.
Mr. Whitman also believed "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." In his view, these 'one size fits all' methods were not suitable for evaluating complex businesses with different divisions. In these situations, different methods are required for each situation.
Considering his preference on assets, it's no surprise that real estate companies featured heavily in the portfolios controlled by Mr. Whitman. He tended to take substantial, high conviction positions in companies and distressed debt believing that diversification only dilutes ideas and returns. The top ten positions commonly accounted for around two-thirds of assets under management. One example was Kmart, as Whitman described in an interview with the Graham & Doddsville newsletter in the fall of 2011:
"Some of my best investments have been in companies that were going through Chapter 11. Kmart was a good example, back in 2003. The first thing we did was buy out a lot of trade claims from creditors. Then we kept averaging down and we went to the official creditors' committee. It was there that we met Eddie Lampert, who asked if we would join him in the reorganization, which we did. Eddie ran everything. To find these types of home runs we really need good partners. We are good investors, but not great managers."
Another example was a large bet Third Avenue placed on Brookfield Asset Management in the early 2000s. Hated by the market, Whitman saw value in the group's US property portfolio and the restructuring of its balance sheet as management sold off underperforming resource businesses, reinvesting the capital back into the asset management business.
For more on Marty Whitman's life, investment style and the mark he's left on the investment world, you can find out more at the ValueWalk Martin Whitman Resource Page.