Authors Forum: Applied Investing

0:00Our next presenter is Joseph Calandro from the University of Connecticut, and he's going to be talking to us about his new book, Applied Investing.

0:17Thank you. It's Applied Value Investing. To give you a background on the talk, I'm going to start with kind of an overview of Benjamin Graham who founded Value Investing and then segue that into how modern value investing practice is practiced. For the simple reason that today's economy is much different than the economy that Graham founded a discipline in and talk a little bit about my research and get into some of the research contained in my book, Applied Value Investing and then Benjamin Graham founded what's known as value investing in the 1920s and 1930s. He was heavily influenced by the new era boom of the 1920s and the subsequent bust or Great Depression.

1:06It's essentially a price arbitrage strategy. He referred to it as cigar butt investing. What he meant by that was companies that were selling at less than their liquidation value were analogous to like an old cigar butt that had a couple puffs of smoke left in it. If you could purchase it below its liquidation value, you essentially could achieve an arbitrage profit, a riskless profit, and that gave you what he called a margin of safety, and that is the cornerstone of the approach, it remains so today, and it's what differentiates an investment from a speculation to Graham and his students. The most famous student obviously is Warren Buffett, the chairman and CEO of Berkshire Hathaway. I actually worked for him at one of his subsidiaries for a number of years.

1:52I'll talk about that if anybody has a question. What differentiates value investing from what's typically being taught in MBA schools today is it's strictly a bottom-up approach, it is not top-down. And as a result, value investors pretty much opposed modern financial economic theory from from the beginning. And to give you an idea of what that means, it essentially has to do with, it's an accumulation of theories, efficient market theory, portfolio theory, a theory that says capital structure doesn't matter, which is probably the dumbest theory on that slide, asset pricing models, option pricing models, pretty much from the beginning. Now they've opposed all that and they've also substantially outperformed the market averages over time. So the modern approach to value investing occurs over a continuum of value, and what I mean by that is it starts with net asset value, and that's essentially reproducing the balance sheet. Balance sheet analysis formed the basis of what Graham did in the 1920s and 30s, and it remains a cornerstone of the approach today. Next we go to earnings

3:03power value, and this is different than the traditional discounted cash flow that MBA are taught and by that I mean it's based on a level of past earnings that should be sustainable into perpetuity. So it's much more tangible than discounted cash flow because you're not projecting out to the future and discounting back. Next you move to franchise value and if there's a spread between your earnings power and your net asset value, that's a tip off that either A, there's a sustainable competitive advantage that you have to value or B, if there's not one and there aren't many, then your earnings One of the keys to the approach is the assumptions are upfront in each level because it's bottom So, that's important. Investment is not, and never will be, purely quantitative.

4:11Everybody kind of says that, but when the rubber hits the road, most people want a simple equation. And the only way to get that is either you assume away all the qualitative and behavioral elements that are inherent in an investment, or you address them up front. So, by way of my background, I came to Austrian economics and value investing late. I was trading currencies and commodities in the 90s and I did, you know, real well for about four years. Year five, fortunes changed very, very quickly in the Asian Contagion. And I really don't want to say too much more about that because it's pretty painful. But re-examining the mistakes I made led me to study value investing formally and also to study Austrian economics, which was fortunate timing-wise, in a sense.

5:04And I say in a sense because if I had done this 10 years before, I'd probably be very wealthy right now. But during that time, I mean, the new economy was booming and there were direct parallels between what I was seeing in the quote-unquote new economy and what Graham wrote about the new era. And obviously, there were definite parallels between what, especially what Murray wrote about the Great Depression and the boom, and again, what I was saying. And significantly, Austrian business cycle theory predicted both the boom and bus waves of both business cycles, which is important, right? Graham, like I said, this is a bottom-up orientation, and Graham's kind of approach to top-down was you know buy during periods of pessimism when prices are low and sell when everybody's like happy and prices are high well I mean I think it could be easier to do that if you understand the macroeconomic reasons driving the optimism and pessimism that's the first thing and then the second thing you

6:07could use I think macro based insights in a Graham and Dodd context to screen for potential investment opportunities and in chapter 5 of my In my book, I essentially present an approach that does that, that integrates Austrian business cycle theory, George Soros' boombust model and behavioral characteristics. Now these are based on a paper that I initially presented at an earlier Austrian Scholars Conference that turned into a published paper in the Quarterly Journal of Austrian Economics and then a working paper, subsequent working paper that's posted at Mises. Several chapters of the book present valuation case studies on high-profile deals. Eddie Lampert's acquisition of Sears, Buffett's acquisitions of Geico and Jean-Rie, and Buffett's alternative investment on the Pepsi Play for a Billion Sweepstakes. Now, I essentially hit the price of each of those investments, and I do so using very, very basic assumptions, and you can see them as you track the cases level by level. Incredibly, this is the first book that actually applies Graham and Dodd to value investments, significant value investments.

7:15I'm not sure why that is. I hope it's not the last. There's another chapter presents an approach on managing, on management, managing for value creation and I'm a manager so that has particular applicability to me and assessing management for valuation purposes. I'm very fortunate that the investment community has really taken to the book top investors like Seth Klarman, Mario Gabelli, and Mitch Jules have given very positive endorsements and it also received two positive reviews from Doug French and CJ Maloney at Mises Daly's. So, questions later. Thank you.