Sunday, April 24, 2011

The Aggressive Conservative Investor: Chapter 6

Martin Whitman founded Third Avenue Value Fund some twenty years ago. Over that time period, the fund has beaten the returns of the S&P 500 by several points annually. In The Aggressive Conservative Investor, Whitman collaborates with Martin Shubik to discuss a concept that they call "safe and cheap" investing.

The authors briefly discuss many of the disclosures public companies must release by SEC requirement, including financial statements and their notes. The usefulness of this paper trail of documents will vary by industry. For example, for a steady dividend-payer in a mature industry, more information will probably be released than the investor needs; however, for a miner or real estate company, GAAP financials are not as useful in determining a company's value.

For the investor to fully fathom the usefulness of these public disclosures, the authors argue it is useful to understand how they are created. For one thing, the lawyers and accountants who prepare many of the disclosure documents have no desire to risk their reputations on a third party (i.e. the company's management). As such, they are rather meticulous in making sure they disclose what they should, and are honest in doing so. Though frauds do occur, the authors believe they are few and far between, especially when compared with normal commercial transactions (where parties must always worry about the truthfulness of the party with which they are transacting).

Investors are also encouraged to obtain copies of the forms and mandated regulations required for filling them out. This will give investors a good idea of what those who fill out the disclosures must go through, and will therefore help the investor understand why a disclosure is laid out as such.

These disclosures also help identify which companies are not worthy of investment no matter what the price! Though many believe that every security is worth something at a low enough price, the authors argue against this line of thought. Some securities are too junior compared to the obligations of the company, and some managements are so egregious in their treatment of shareholders, that some securities should be discarded outright based on their disclosures.

Finally, it's important to recognize what's not contained in the disclosures. Internal budgets, management disagreements, marketing plans and other such matters in which shareholders might be interested are not normally disclosed. Often, projections, budgets and asset appraisals can be used for stock manipulation, so in some cases it is better that such "soft" details are left out. Nevertheless, the authors argue that in many cases these disclosures are so useful that they are all the investor will need to form an opinion of whether a security is worthy of investment.

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