DEEP VALUE Supplementary Readings for Ch. 2, Deep Value


Below are supplementary readings and original sources for Chapter 2, Contrarians at the Gate, in Deep Value. This is an important chapter because we are introduced to the father of security analysis. He was the first person to systematize his analysis and separate the price of a security from its intrinsic value.

I realize that some may find Graham fusty and his prose turgid/boring, but Graham was a Renaissance man who had a razor-sharp intellect and integrity.  You can’t lose by reading his works.  Note his attitude, skepticism, and logic.

So far in the course I am surprised by the ironies and subtleties of Deep Value investing–picked up in the preface of the book, Deep Value.  Our Deep Value Group has close to 400 members, yet, currently (Jan. 17, 2015), the number of net/nets in the US market is negligible.  Financial assets (with a few exceptions) are sky-high in valuation due to Central Bank intervention, negative interest rates, and a six-year upward trend in US bonds and stocks.  I am surprised at the interest.

We invest today for the future, but the future is unknowable. Look at the predictive record of experts!  Investors tend to extrapolate the past into the future just in time for a reversal of fortune–reversion to the mean reverses the trend.

Deep value investing takes advantages of the cognitive biases of others to gain profits, but if we are human too then how do we avoid the same?  Cheapness or the discount from intrinsic value is the main determinant of margin of safety. The cheaper you buy the less risk and MORE reward. This smashes academic finance theory in the face.

Here I am quite surprised that the highest returns to the net/net strategy go to the MONEY-LOSING companies. The worst of the ugly gain the most. Perhaps because price drops the most due to fear and earnings trend extrapolation.  Like assuming the driver of the car will continue to motor off the cliff instead of turning or stopping the car.

A TEST: Let’s say a company earned $5 per share and it is growing at 5% per year, the cost of capital is 10%, and it is trading at $85 per share. Then the next year earnings drop to $1 per share and the following year earnings drop to $0.05 or five cents, the next year earnings go up to $3 and in the fifth year back to $5.25 and 5% growth. After ten years the company will continue to grow but only at 3%.  Guess the price drop quickly and write it down.  Now do the DCF and see where the intrinsic value is compared to your guess.

Last year $5.00

Year 1 $5.25

Year 2: $1.00

Year 3: $0.05

Year 4: $3.00

Year 5: $5.25

Year 6: $5.51 (5% growth)

…. next year, next year, etc.

After year 10, then terminal value 10% cost of capital with 3% perpetual growth. Can a financial wizard post in the comments section?  Was anyone surprised by your initial reaction the Intrinsic value result vs. their initial thoughts on how price would react?

Back to the post….

The higher probability (Montier, 5%) for each INDIVIDUAL company to go down 90% or more vs. 2% of non net/nets may cause other investors to shy away from investing. HOWEVER, the GROUP of net/nets STILL outperforms.   You have certain companies go to zero and some rebound multiple times but you don’t know which ones.  You have to deal with much uncertainty but believe you are playing the odds like an insurance company.

When net/nets are abundant like in 1932, the world appears to be ending. Investor fear is off the charts. The question is whether you will have the capital to buy and the courage to act. Again we come round and round to temperament or character or whatever you want to call acting in the face massive fear.

But knowing that a company is too cheap when it trades at less than 2/3rds to net asset value (Asset value is tenuous, liabilities are 100 cents on the dollar) does not seem difficult, but probably the surrounding circumstances for the company and/or market are ugly! “Don’t you read the papers!” an outsider might say if he or she learned of your purchase.

Remember 2009? Jim Cramer in a panic.   (just paste into your browser)

Those are my thoughts and questions so far as I keep reading.

Graham’s Writings and Testimony

Graham Testimony to Congress (note his remarks on the MYSTERY of price eventually closing the gap with intrinsic value)

Important writings on Liquidation Values during the 1930s

1932_American Corporations Worth More Dead than Alive 3 Parts by B Grahams  (Please read). You can’t understand the depths of despair in the financial markets (and thus the net/nets and prices below liquidation values) without understanding the preceding boom.

Historical perspective

A Study of Market History through Graham Babson Buffett and Others  The 1920s BOOM.

A Great Depression_Rothbard Obviously, you don’t have time to read this, but IF you do want to understand the causes of the biggest bear market in US history then this is the definitive work.  The book destroys the common wisdom that the depression was caused by the Fed’s tight monetary policy.

The Outperformance of Net/Nets

Net NEt Strategy in London


Benjamin-Graham-s-Net-Nets-Seventy-Five-Years-Old-and-Outperforming  I imagine that some net/nets are micro/nano-cap stocks under 50 million in market cap and with wide (5% to 10% bid/offer spreads) perhaps the studies do not deduct the spread?

There is a lot here so I will refrain from posting until the middle of the week. Take your time with Chapter 2.   I will be posting next on Klarman’s thoughts on liquidation and valuation.

Traditional finance savaged: The Dumbest Ideas in Finance_Montier

 How NOT to take this course

You don’t have to read EVERYTHING, but you do have a choice. Better to understand what you read.

Thinking Differently (Money Ball); Munsingwear Analysis


I HIGHLY recommend you go see Money Ball or read the book by Michael Lewis.  A metaphor for deep value investing.

Case Study – Munsingwear Analysis Q&A

Who earned their wingtips?  That case was about approaching the problem as a business person.  First you had to notice the two businesses, then break them out. Stop the bleeding, then leave the rest.  Often, the smartest students struggle to resurrect the uncompetitive business. (Buffett at Berkshire Hathaway!)

Next, I will post some questions and supplementary readings for Chapter Two in DEEP VALUE (the book) over the weekend.

Enjoy your Weekend!

DEEP VALUE Videos on Net/Nets and Investing

Closing Arg

How is it possible that an issue with the splendid records of Tonopah Mining should sell at less than the company’s cash assets alone? Three explanations of this strange situation may be given. The company’s rich mines at Tonopah are known to be virtually exhausted. At the same time the strenuous efforts of the Exploration Department to develop new properties have met with but indifferent success. Finally, the drop in the price of silver last year has provided another bearish argument. It is this combination of unfavorable factors which has carried the price down from $7  1/8 in 1917 to its present low of $1  3/8 in 1923.

Granting that the operating outlook is uncertain, one must still marvel at the triumph of pessimism which refused to value the issue at even the amount of its cash and marketable investments; particularly since there is every reason to believe that the company’s holdings in the Tonopah and Goldfield railroad, are themselves intrinsically worth the present selling price. (Ben Graham on Investing)


Marty Whitman criticizes Graham and Net Nets (3 minutes Must see!)

Marty Whitman: They Just Don’t Get it.  (23 minutes) Marty says many analysts on Wall Street do not understand credit analysis.   We will explore later in this course whether the quality of credit provides a better assessment of the true cost of capital for a firm rather than “beta.”

One investor’s experience investing in Net/Nets (3 minutes)

Net/nets as value traps (5 minutes)

Good advice on behavioral investing (3.5 minutes)

Prof. Greenwald on UGLY and Cheap or Graham’s Search Strategy (8 minutes)

Greenwald on the Balance Sheet (risk of financials) (10 minutes)

Deep Value Group at Google


With about 500 “students” enrolled, emailing individually is difficult because of limits to prevent spam. I started a DEEP VALUE group (in  communities) at Google.    Click on the link below (if you haven’t already joined–I sent out an invite to all my distribution list this morning).  You may be required to have a Gmail account, but that is an easy process.  Then you can keep your course work separate from your usual emails.

I will be communicating via emails with this DEEP VALUE group as well as posting here.  If you decide not to join the group, you can still email questions/comments to me at!overview then type: DEEP-VALUE and ask to join.

Hannibal Lecter on How to Read Ben Graham

What is its nature?


Read Marcus_Aurelius, First principles,    S I M P L I C I T Y.

For each particular, what is it in itself? What is its nature?  Why does he kill? Because he covets!

In your Readings for Lesson 3: Graham’s Liquidations and Net/Nets think about principles not accounting conventions.  When is a current asset not current? Can a fixed asset be more current than a current asset on the balance sheet?

Finally, when you are looking at a balance sheet, always think of this


Google only lets me send emails to 500 people in one day. There are 497 enrollees in the deep value course.   So I can only email by group. I will be sending out invites to all enrollees in DEEP VALUE

So consider joining or else you won’t receive emails. Email communication will typically be updated on the most recent blog post at

We already have volunteers for Schloss, Tweedy Browne, Greenblatt, and Buffett. Thanks for the quick response.  No more volunteers for now. But I DO need a volunteer to date My Ex-Wife.

All Course Materials Sent via Hightail Link to Your Email

Once again, if you did not receive this link in your email, let me know at because it means that you are not enrolled and not on the distribution list.

UPDATE 12:40 PM:  It looks like my aol emails are not getting through. I will be using instead to send you communications.   Use the link below instead of the email link I sent you IF you are asked for a password. Sorry. We are getting there. ALL course materials for now can be downloaded below.

from via Hightail.
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IMPORTANT: Email Distribution List for DEEP VALUE COURSE

I just sent SECURITY ANALYSIS (PDF) to EVERYONE (503 enrollees) on my distribution list for the DEEP VALUE COURSE under TWO emails: and

We have to have an efficient distribution list so you can get assignments/readings.    Perhaps, I should have used google drop box or some other method.   But I don’t see why emails can’t work.

SO, if you are ENROLLED in the course AND you did not receive TWO emails with Sec. Analysis attached, then email me AGAIN at with STILL NO SECURITY ANALYSIS.

Check your spam folders to let the emails through.

Once I know that the FULL distribution list is working I will RE-EMAIL all the materials that you should have to this point in the course.

Let’s get it right because receiving 250 emails from students who did NOT receive THE Intelligent Investor and Sec. Analysis is very time consuming.

THANKS, John Chew


Reading Assignments; The Institutional Imperative


All Enrollees in the DEEP VALUE COURSE should have been emailed Security Analysis and The Intelligent Investor.

Please read Chapters 42 – 45 (on the Balance Sheet). Especially focus on Chapter 43, Significance of Current Asset Value in Security Analysis, (pages: 548-613)

Read Chapter 15 in the Intelligent Investor (pages 376-402)

Chapter 22, Graham’s Net-Nets: Outdated or Outstanding in Montier’s Value Investing,  (Pages 229-235)

Chapter 2, Contrarians at the Gate in Deep Value, (pages 19 -34)

Chapters 1 & 2 in Quantitative Value (pages 3 – 59)

A total of about 168 pages.   This is to give you an early start for next week.  If you are short on time, then just read Ch. 2 in DEEP VALUE. 

If you didn’t receive any of those books, then 1) check your spam folder, 2. email me at with the title BOOKS and what you are missing.  3. if you receive an email with material that you have already received, then ignore/delete.

The Institutional Imperative
Sometimes institutions get caught up in the moment as well.  A company I used to work for held the Fairholme fund in two separate strategies in 2010.  At the end of 2010 I was able to convince the group to completely sell out of the fund in the smaller strategy, but it remained in the larger strategy.  In 2011, the Fairholme fund lost about 32% when the S&P 500 was up 2%.


At the end of 2011 I (the author of this article, link below) was able to convince the group to add the Fairholme fund back to the smaller strategy, but was unable to convince them to even maintain its weighting in the larger one.  Instead the group decided to cut the allocation in the larger strategy in half, despite my objections.  The argument was that the volatility and amount of underperformance (What about Regression to the Mean?) was too great.  The amount of underperformance was one of the reasons to add it back to the smaller strategy and in my experience returns trump volatility as volatility can actually be your friend.  In 2012, Fairholme was up about 35% which almost beat the S&P 500 by 20%.  In the end it was the clients that were hurt as the investment group followed the herd, on the larger strategy at least, keeping a manager after great performance and selling them after poor performance.  Read more….

The institutional-imperative

Institutional Investors and Analysts tend to herd-like behavior by acting late after trends are established.

Goldman cuts oil outlook, so NOW you tell us! (Perhaps, a tad late on the ADVICE!)

Working at Goldman Sachs



Repetitio est mater studiorum,” says the Latin proverb – repetition is the mother of all learning.

Lessons for this post:

  1. Know what you are doing.
  2. Avoid paying massive premiums over net asset values.

Below is CUBA, a closed-end fund investing in companies that invest in Cuba or will benefit by an increase in business with Cuba. Note the spike upward on the announcement that Obama would allow a prisoner exchange and take Cuba off the US’s terror list opening up the possibility of the end of the US embargo.

large CUBA

Now go: CUBA NAV Summary  (Click on the button, since exception on the right side of the page, to see the history of price vs. Net Asset Value (“NAV”). Note the results last time “investors”/speculators or the confused paid in excess of 50% to the underlying stocks. We can argue about the intrinsic values of the underlying stocks but not the prices–because price is what it is. Mr. Market has spoken.

Here we are todaysmall cuba

Go back and click on CUBA NAV Summary and view the one year summary. Note that the price reached a 70% premium to the NAV AFTER the news event of “improving” US/Cuba relations.   Upon hearing the news:

My first post on CUBA (CEF) SELL!  Can I predict? No, just common-sense.

Where is the efficient market? Perhaps the unavailability of shares to borrow hindered arbitrageurs who could buy the underlying stocks and short the closed-end fund (“CEF”), CUBA.  But to pay such a premium is almost a guaranteed loss unless sold to a greater fool who will pay an even more absurd premium. That is speculating not investing. What is business-like about paying a 70% premium after a news event?

A closed-end fund sells a fixed number of shares to investors. For example, let’s pretend we start a closed-end fund to buy stocks, called the BS Fund. We sell 10 shares at $10 each for $100 in capital, then we buy 1 share of Company X at $50 and 2 shares of Company Y for $25 (ignoring commissions and fees). The net asset value (NAV) is ($50 times 1 share) + ($25 times 2 shares) = $100.   The net asset value per share is also $10.  So the price per share of the CEF ($10) trades at no premium (0) to the NAV per share $100/10 shares.  Now an investor wants to sell 3 of his BS (CEF shares) to an investor who bids for them at $9.00 per share.  Unless, the underlying share prices of Company X and Y change, then the discount is now 10%.  We, as the management, must institute a decision to buy back shares of the BS fund to close the discount or investors increase their demand for the shares.

Carl Icahn got his start as a closed end fund arbitrageur, who would force the managements of the closed-ends funds that traded at large discounts to NAV, to buy-back their shares.

Setting aside the emotional impact of the news announcement, the prisoner exchange and Obama’s reducing of sanctions doesn’t change much.  By the way, if sanctions and embargos don’t work (I agree) as Obama claims then why the sanctions on Russia? If the Russians didn’t surrender during Stalingrad, what are the odds now? Color me cynical.

The US is ALREADY one of the top ten trading partners with Cuba. Of course, the embargo is a farce, kept in place for political purposes. Congress still has to vote to remove the embargo, but even without the embargo Cuba lacks the production of goods and services to trade. Why? Cubans lack the capital to produce because they lack the security of property rights and the rule of law to acquire capital. No Habeas Corpus, no freedom of speech, and no rights. No tyranny generates LONG-TERM economic growth.

What returns will foreign investors require to invest in Cuba?  Say you whip out your spread-sheet and suggest 25% annual returns to build a new hotel in Cuba based on your projection of American tourists hitting the shores of Cuba like locusts.  Two years after the hotel is built, Raul Castro and his military cronies tears up your contract. Investment lost.  Without the rule of law and sanctity of contract, the rest means little. The first lesson is to know what you are doing.

Life in Cuba:

  1. Tengo Hambre A Cuban Says I AM HUNGRY!
  2. Life for Cuban Youth (Cuba with highest suicide rates in the Western Hemisphere.

The investor who buys CUBA would have to understand what the current changes mean for the companies in the fund. Anyone who spends time understanding the current economic conditions there would grasp how little the current announcement means for investment there.  Ask the Canadian investor rotting in a Cuban jail today Canadian investor rots in Cuban jail.

Speculators were willing to pay at 70% premium AFTER the price of the underlying companies had moved higher by 10% to 15% on the news.  A premium on top of a premium–a lesson of what NOT to do.   Questions?

If anyone in this class does that, then this awaits: No Excuse

Lecture 1; Lesson 2: A DEEP Value Investor/Activist in Action


Lecture 1 The main points from Lesson 1

Jot down his numbers. Do you agree?  Read through the transcript Other Peoples Money_2 then see the video again.  What you saw was value investing in action.  Many of my videos are meant to entertain but this one has much to teach. Note his SEARCH and VALUATION PROCESS.

Now view the activist. Note the divergent incentives.

A Prayer   (Video link) What do YOU think?

A Prayer for the Dead. Amen, Amen, and Amen.

For Masters of the Universe (Investment Bankers)

Try this case study. Case Study – Munsingwear.  If you struggle, here is a hint: What would you tell someone who kept banging their head on the wall and complained of a headache?  In five days I will post the answer. This is an actual case so don’t cheat by Googling it.  This case is about thinking like Larry the Liquidator :).

Next week, I will post more on Lecture 1 and you should plan to read Chapter two in DEEP VALUE and the Chapters 1 & 2 in Quantitative Value. We will study those chapters AFTER next week. I am just giving you notice.