Book Review: The Aggressive Conservative Investor By Martin Whitman

2009 August 11
by Kyle Bumpus
from → Book Reviews

Martin Whitman is no stranger to finance nerds such as myself.  He is the founder of the well-respected Third Avenue Management fund shop and fund manager of Third Avenue Value (TAVFX), which has absolutely trounced the market averages over the trailing 10 year period.  Indeed, Whitman’s fund is one of the few to earn more than 5% per year over the past decade.

In addition to The Aggressive Conservative Investor, Whitman has also written an excellent primer on value investing entitled Value Investing: A Balanced Approach and a brand-new book called Distress Investing: Principles and Technique, which I’ve yet to read but look forward to.

The Aggressive Conservative Investor Review

I’ve mentioned before that this is among my favorite all-time investing books; however, it’s not without its flaws.  For starters, Martin Whitman writes in a matter-of-fact, business-like style that seems to suit perfectly his investment approach:  he zeros in on what matters and discards the rest, even when “the rest” happens to be mainstream conventional investment wisdom.  He has no trouble making authoritative assertions, as if the correct answer is obvious and it’s inconceivable anyone could possibly disagree.  Fortunately for him, he’s usually right; however, his dismissive tone can sometimes hit a nerve in his ideological opponents.

Whitman’s Investment Thesis

The financial integrity approach
to company valuation focuses on finding
companies with strong financial positions
selling at substantial discounts to
readily-discernible net asset values.

Companies with few encumbrances and
strong cash flows are given special
consideration under this approach.

Whitman’s investment thesis in  The Aggressive Conservative Investor centers around the financial integrity approach to company valuation, or what he likes to call the cheap and safe approach.  The book is written from the perspective of a real finance insider, somebody who knows how Wall Street really works.  In the massive appendices at the end of the book, Whitman walks you through two complete and highly-complex real-world case studies of actual corporate deals consummated in the decade leading up to the writing of this book (late 60′s – mid 70′s).

A central tenant of the financial integrity approach is the idea that all aspects of a company’s financial position are equally important in determining the company’s future earnings potential.  That is, no single attribute has value in isolation of the rest and everything from the balance sheet, cash flow, and income statements work together to help determine the company’s true value.  By contrast, conventional Wall Street wisdom holds that the income statement is the most important determinant of a company’s true investment value, with current accounting earnings being the single largest factor.  Whitman disagrees.

While he admits that current accounting earnings often do have the most effect on short-term price fluctuations, it rarely if ever gives a good picture of what the true future earning potential of a company is.  To Whitman, the majority of publicly-traded companies are involved in what he calls asset conversion activities of some kind or another.  An asset conversion activity is merely the act of a company converting an asset from one use to another, hopefully in a more useful way.  A prime example would be an industrial company selling of some of its valuable real estate holdings in order to finance additional manufacturing capacity.  While real estate holdings are an asset to any company, including industrials, they are relatively unproductive assets much of the time since they tie up cash that could be used to create the capacity needed for future earnings increases.  In this case, the investment extra manufacturing capacity made possible by liquidating non-productive real estate assets will drive higher profits for years if not decades to come.  By converting real estate assets to industrial assets, are example corporation has engaged in a form of asset conversion.  These conversions, posits Whitman, are usually the true source of wealth creation in the economy.

Who Should Read This Book?

Absolutely anybody interested in corporate finance and especially stock picking should read this book.  Whitman’s insights into how business leaders actually value whole companies in practice is pure gold for the individual investor.  You may be surprised to find that few movers-and-shakers use the same techniques as outside securities analysts when valuing companies.  Whitman cuts through the crap and shows you how deals are actually done in the real world and gives a glimpse of some of the financial wizardry corporate insiders almost always go through to get the best deal for themselves, often at the expense of outside investors.

If you have ever bought an individual stock, or ever plan to, you must read this book.  Even if you are a passive index investor, you will find this book fascinating if you have a general interest in the fields of economics or finance.  Investors who just want to know which mutual funds to buy and the basics of asset allocation so they can forget about it and go about their lives will undoubtedly find this book boring.  For them, I would recommend Richard Ferri’s All About Asset Allocation instead.

Buy The Aggressive Conservative Investor by Martin Whitman from Amazon.

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