A popular picture of bargain-minded value investors portrays them first and foremost as number-crunchers.
Never mind the headline on the press release: Show them the footnotes, the data deep in the balance sheet. In a classic embodiment of this image, a photo of veteran mutual fund manager Martin Whitman on his company's Web site shows him with his face buried in a financial document.
So it comes as a jolt to read Whitman's latest annual shareholder letter. He writes that an ability to dig out bargains in itself probably hasn't been the key to his success as founder and chairman of the 30-year-old Third Avenue Management LLC and manager of its flagship Third Avenue Value Fund.
"Rather, the fund's best investments revolved around being in bed with superior managements who were able to be opportunistic on a long-term basis," he wrote.
Whitman can speak as a voice of experience. In the past year, as he marked his 80th birthday, the mutual funds part of Third Avenue's business hit best-seller lists with a jump in assets from $4.9 billion at the end of January 2004 to $8.3 billion a year later, according to the consulting firm Financial Research Corp. in Boston.
The $4.3 billion Third Avenue Fund gained 26.6 percent in 2004 to rank among the top 1 percent of value funds tracked by Bloomberg. Over the past three years, according to Bloomberg data, the fund has returned 14.2 percent a year while the Standard & Poor's 500-stock index has advanced at a 2.5 percent annual pace, including dividends.
Whitman said the superior managements of which he writes "seem to focus on the same thing [Third Avenue Value Fund] focuses on as a buy-and-hold investor; i.e., long-term wealth creation. The primary focus is not on what periodic reported earnings per share might be."
He said the best-managed companies typically enjoy enough financial strength to be able to pick and choose when they turn to the markets for capital, if they need to do that at all. In that position, he said, "the managements tend to be non-promotional and, at times, hardly interested at all in what Wall Street thinks."
There is no such thing, Whitman added, as a perfect management free from all conflicts of interest with outside investors such as Third Avenue. The trick, he said, is to find cases in which interests in common outweigh the conflicts.
Whitman is famous for a plain-spoken candor not often seen in a business that emphasizes fiduciary decorum. A couple of years ago, for instance, while many investment analysts were talking up a new tax break for dividends as a stimulus for the stock market, Whitman told a conference on the subject, "It's phony baloney."
No surprise, then, to find him bluntly acknowledging that his study of managements is fraught with difficulty and mistakes. "The fund is prone to misjudgments," he wrote. "It seems to me that the vast majority of TAVF's misjudgments have revolved around being in bed with the wrong management from a fund point of view, rather than any purely financial factors."
If reading the people who run companies is so hard for a pro like Whitman, what chance does an ordinary individual investor have? There's at least one principle here that anyone can apply.
Once an investor establishes a mission -- say, long-term growth of money toward an old age 10 or 15 years hence -- he or she can look for evidence that management pursues compatible objectives.
If a company or a fund trumpets short-term performance, that's a negative sign, suggesting that the motive is to attract new investors rather than to enrich existing ones.
Whitman said he is "very much against corporate beefing up of quarterly reported earnings per share when, and if, the striving diminishes opportunities for long-term wealth creation. For example, operating earnings are taxable and unrealized appreciation is not. Not paying taxes increases resources available for wealth creation."
The idea that the human factor, more than numbers, ultimately makes the difference helps to answer another important question about investing. It may explain why people like Whitman never lose their enthusiasm for the game.