The Man Who Outperformed Warren Buffett
by Dr. Mark Skousen, Investment U Contributing Editor
Friday, March 25, 2011: Issue #1477
“Sometimes it’s not what you own, but what you don’t own that makes you successful.” – Donald G. Smith, Wall Street veteran
Last week, I picked up the new, 10th edition of A Random Walk Down Wall Street by Burton G. Malkiel – a longtime friend and Professor of Economics at Princeton University.
I well remember the time I sat in his office in December 1999, as we stared in awe at a chart of the S&P 500. We were right in the heart of the dot-com bubble and the index was blasting into the stratosphere under the influence of the boom.
We knew it couldn’t last and that the bubble would burst.
But despite knowing that the stock market had become way overvalued in 2000, great market timing is rare.
The most successful investors are long-term fundamentalists, who buy sound companies and hold them over time. Warren Buffett is a classic example, with Berkshire Hathaway consistently beating the S&P 500 for decades.
Over the past 10 years, Berkshire hasn’t performed as well, but it’s still easily beaten the stock indexes (which have been in a 10-year bear market).
However, there’s a guy who may have done as well as Warren Buffett over the past 30 years… if not better…
Want to Outperform the Market? Look to This Key Ratio…
I’m talking about Wall Street veteran, Donald G. Smith.
Holding an MBA from Harvard and a law degree from UCLA, Don uses a different approach. He specializes in finding “deep value” companies, whose fundamentals turn positive.
Among the many factors that stock analysts use – such as price-to-sales, price-to-earnings, price-to-dividends, return on equity, etc. – Don discovered that the price-to-book ratio offers the most opportunity to outperform. And especially stocks selling below their book value.
After going through an in-depth screening process, evaluating out-of-favor companies, Smith attempts to measure “tangible” book value using various factors. He adjusts for hidden assets, goodwill and dilution from options and convertible debt. His company spends time talking to company executives and conducts hands-on due diligence to determine the company’s future prospects.
Smith says, “We stress test. That’s the first of the value traps, buying something that ends up going bankrupt on you. The second trap is buying a cheap asset that stays cheap forever.”
Smith seeks to avoid both. And how have his investigative techniques worked out?
The “On Sale” Sign is Hanging Over These Three Sectors
In over 30 years since its inception, Donald Smith & Co. has earned a compounded annual return of 15.3%. And over the past 10 years, when the stock market has gone nowhere, his company’s annual return is 12.1%.
So what is Smith & Co. buying now?
Three sectors that jump out include…
Dr. Mark Skousen
*The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.