Secondary Companies Part 1

A young man, Shai Dardashti, asked Buffett the question that if he were running a smaller amount of money ($10 million), would it be better to invest them in good companies at fair prices or fair companies at cheap prices. Buffett answered that for smaller sums, purchasing fair companies at cheap prices would be better.

What exactly are these fair companies? According to Graham, these companies could be secondary stocks. Stocks that are not well known, may not demonstrate a wonderful history as blue chip stocks in terms of profitability and generally out of favor because of some disappointing performance and outlook in their business. When I met Edwin Schloss, he gave me 4 tips on what i should buy and two of those companies are having disappointing performance and facing uncertainties in their future. A broker/analyst that he referred me to told me to take a look at an insurance company that is recently facing massive losses at one of their insurance products.

I must admit that when first faced with these companies, there was a bit of shock and fear in putting money in some of them. I believe that the general market would have the same impressions as I did when looking at these companies. To add to that, the falling of their stock prices would further the fear of people from these companies in general.

When I started investing, I could easily find so many companies that were selling way high from their appraised value than I could find companies that were statistically cheap. I guess this must be because I was always looking at companies that had been performing really really well in the last couple of years. I wasn't looking at companies that are out of favor. I guess you can say my first exposure to companies that are out of favor and with uncertain future came from my experience with Edwin Schloss. I must admit that if this came from somebody else, I might have immediately dismissed it without further thought, but this came from Edwin Schloss who along with his father has one of the world's best 50 year track record.

Does Edwin Schloss really put his money into companies as uncertain as the ones he recommended to me? I believe so. I've read a book that says that when the Schloss' father and son team started, they revealed some of their holdings and in turn lost some of their clients who got scared. I also read a recent article online that has Walter Schloss looking at a company that manufactures OEM wheels for big car manufacturers. That company has been performing pretty bad recently and they have been buying it when the price went down. Also, this approach to buying out of favor companies or secondary companies is consistent with their mentor Benjamin Graham's teaching and is also consistent with the world's best value investor's, Warren Buffett, approach when he started with smaller sums of money.

At this year's Berkshire annual meeting, Buffett was again asked what would he invest on if he only had a few million USD. Buffett said he would look at smaller companies and distressed bonds. Now I've been looking at smaller companies recently (over 700) and I can't name you companies that have a great outlook. Smaller companies in general are secondary companies. I also read a book where a man named Heilbrunn went to Benjamin Graham to have him become his financial adviser for his portfolio. When Benjamin Graham first looked at his portfolio, he told him to immediately sell all of them. Heilbrunn was shocked and told him if he's sure because the portfolio was invested in great companies. Graham replied saying that yes he is sure because the portfolio will never perform better than those great companies will. After selling them all, Graham immediately invested the funds in DISTRESSED BONDS! Ever since then, Heilbrunn's portfolio record has progressed really really well until he died. I believe he donated a building to Columbia University.

It's very easy to find secondary and out of favor companies that have a certain level of uncertainties in them. What you must screen for are companies that are low risk and uncertain when looking at out of favor companies. Many uncertain companies have high risk levels in them. We cannot underestimate the market's ability to appraise companies given that they can be irrational and not always correct.