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Course 509
Great Investors: Marty Whitman

Introduction

Marty Whitman is a vulture of a value investor. He can usually be found rummaging through the rubble of distressed stocks--those of beaten-down companies, some on the brink of insolvency. But most of Whitman's depressed stock plays eventually turn around for the better. That is why Third Avenue Value TAVFX, the mutual fund that Whitman has managed since 1990, sported a five-year annualized return of 17% at the end of 1999--impressive in light of the market's blatant favoritism for growth throughout the 1990s. The key to Whitmanesque stock-picking: Buy companies that are cheap and safe, and hold onto them.

Cheap as Measured by Takeover Value

Whitman is a value investor after Benjamin Graham's own heart. (We discuss Graham in Stocks 506.) Like Graham, Whitman looks for stocks that are dirt cheap, but the two investors use different measuring sticks. Graham used a company's price/book ratio to determine whether its stock was cheap. He wouldn't buy a company unless its stock was trading for less than 1.2 times book value per share. (A company's book value is essentially its assets minus its debts.) Whitman takes a different approach. He focuses on a company's takeover value, or how much he thinks a buyer would pay to buy the whole company. Whitman doesn't like to use book value because he says it overlooks too many intangibles. For instance, a money-management firm can sell its services over the telephone. Such telephone calls are assets, so to speak, but they don't appear as such on a company's balance sheet. According to Whitman, takeover value accounts for such intangibles. Whitman combs through a company's financial statements to figure out what he thinks the business is worth. He then looks to see whether the company’s balance sheet has remained strong in spite of setbacks in the business. He will generally pay no more than 50% of what he thinks a buyer would pay to acquire the whole firm. Whitman's criteria for a safe stock could be represented in this way: Safe = little debt + great assets + low overhead According to Whitman, a stock is safe if it meets three criteria:

1. The company has very little debt on its books.
Whitman looks for debt on the balance sheet and in the footnotes of the company's financial statements as he has seen companies downplay hefty liabilities by burying items in notes. Because he is sometimes investing in troubled companies, Whitman doesn’t like firms overburdened by debt: Debt can make a company’s troubles even worse. 2. The company has high-quality assets.
Whitman defines a high-quality asset as cash or real estate. He’s looking for assets with value, and what could have more value than cold, hard cash or lucrative real estate? 3. The company doesn't require a huge overhead to generate cash.
Whitman likes his companies to be able to make money without spending a lot of money. A money-management firm, for example, can conduct its business via the telephone or in a face-to-face meeting, which doesn't cost a lot.

Patience

It can take a long time to unlock the value of a beaten-up stock. For example, Japanese insurance conglomerate Tokio Marine and Fire Insurance TKIOY was Third Avenue Value's largest holding at one point. Whitman thought Tokio was a high quality business that was selling for much less than its actual worth. The insurer had experienced its share of troubles, but Whitman was willing to wait out the storm for a return down the road. The return eventually came, taking what may have seemed an eternity to others. As long as a company is safe and cheap, Whitman is willing to wait. And as Third Avenue Value’s long-term numbers attest, the wait is generally worth it.

Quiz 509
There is only one correct answer to each question.

1 What two qualities does Whitman look for in a stock?
a. Expensive and safe.
b. Safe and cheap.
c. Shaky and insolvent.
2 What stock would be considered cheap to Whitman?
a. One trading for less than 1.2 times book value per share.
b. One trading below its historical price/earnings ratio.
c. One selling 50% below the company's takeover value.
3 What company would be considered safe to Whitman?
a. One with little debt, few assets, and few workers.
b. One with little debt, high-quality assets, and modest overhead.
c. One with little debt, substantial free cash flow, and huge book value.
4 Why is patience a key part of Whitman's approach?
a. Because there aren't many stocks that fit his criteria.
b. Because it can take a long time to unlock the value of a beaten-up stock.
c. Because it takes so long to calculate a company's takeover value.
5 Why does Whitman prefer takeover value to book value?
a. Book value doesn't always account for intangible assets.
b. Book value is too generous and tends to overvalue a company.
c. Too many other managers use book value to determine a company's worth.
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