Francis Chou, of Chou Associates, in Toronto.Della Rollins/The Globe and Mail
Value investing requires a strong stomach, says Francis Chou, who’s been proving that for 40-plus years as chief executive officer of Chou Associates Management Inc. in Toronto.
Mr. Chou says the recent market volatility shows the benefits of holding your ground – and the perils of straying off course – when it comes to a security’s intrinsic value.
“Every five to 10 years you will go through a period where stocks that are overvalued will still go up and become more overvalued, whereas stocks that are undervalued go down in price and become more undervalued,” he says. “That’s the time when you need to have a strong sense of conviction of who you are and how you’re going to invest.”
Such resolve has brought healthy returns for Mr. Chou, portfolio manager of two Lipper Award recipients for 2022, the Chou Bond Fund Series F, which won in the Global Fixed Income Balanced category, and the Chou RRSP Fund Series F, which won in the Canadian Focused Small/Mid Cap Equity category.
The equity-based RRSP fund, with a management expense ratio (MER) of 1.59 per cent and about $38-million invested, returned 2.34 per cent over one year and 19.82 per cent over three years ending Sept. 30.That compares with a 16.28-per-cent drop over one year and gain of 5.92 per cent over three years in the Morningstar Canadian Focused Small/Mid Capital Equity category over the same period.
His bond fund, with an MER of 1.72 per cent and about $10-million invested, returned 15.37 per cent over one year and 28.8 per cent over three years ending Sept. 30. That compares with a drop of 11.06 per cent over one year and a decrease of 0.71 per cent over three years in the Morningstar Global Fixed Income Balanced category over the same period.he results are based on total returns and are net of fees.
Mr. Chounotes some securities that were soaring in the last couple of years are now down 70 per cent or more. “They’re not bad companies, they’re good companies, but they were way overpriced at one point,” which brought people to chase them “just because they were going up, but not in terms of evaluation. It’s like fool’s gold.”
He did quite the opposite, singling out bonds and equities that he considered undervalued and cheap enough to take the plunge. For instance, when the COVID-19 pandemic hit and he saw bonds in the oil-and-gas sector plummet, he “exploited that situation.” The fund invested in Athabasca Oil Corp. (ATH-T) in 2020 at 23.5 cents and sold it in 2021 at $1.“We made more than four times the money,” he says.
In his RRSP fund, he invested in Resolute Forest Products Inc. (RFP-T), which hit a low of just over $1, and the company is now being bought by a subsidiary of Domtar for $20.50 a share. “When it was trading at one buck a share, everyone was saying, ‘You’re a big dummy, you should sell it,’ ” he recalls. “But that is the time when you should load up on it.”
Mr. Chou is not finding much value in bonds right now, given rising interest rates. Indeed, the Chou Bond Fund had 49 per cent in cash on June 30 and more than 60 per cent in cash on Sept. 30.
He still sees bargains, however, in the equity market. One of his recent picks was Home Capital Group Inc. (HCG-T), which was recently trading at about 70 per cent of its tangible book value.
On Monday, billionaire financier Stephen Smith announced a $1.7-billion deal for the alternative mortgage lender. The cash offer of $44 a share would see a subsidiary of Smith Financial Corp., a company Mr. Smith controls that already owns 9.1 per cent of Home Capital, acquire all the remaining shares.
The offer represents a 63-per-cent premium to the mortgage lender’s closing stock price last Friday. The agreement includes a “go-shop period” until Dec. 30, during which Home Capital and its financial advisers can solicit bids and enter into negotiations with other potential buyers.
“Stephen Smith is a smart cookie,” Mr. Chou said in an e-mail Tuesday. “The price he is paying for getting 100 per cent of Home Capital Group is a steal in broad daylight. Home Capital Group is estimated to earn at least $5 per share in 2023 – the purchase price is only 8.8 earnings for a high-quality company.”
Mr. Chou, whose RRSP Fund owns 25,000 shares in Home Capital, said he is not voting for the deal.
The Globe spoke to Mr. Chou about playing it safe in bonds, scouting bargains in equities and finding value in both.
Describe your investing strategy.
I always buy stuff related to what the company is worth, and if it remains undervalued, I’ll keep holding it. There are many ways to value a company: One is based on how much the company would earn in cash over a 10-year period. The second is mergers and acquisitions, looking at what a rational buyer would pay for the company, or part of it. You have some guidelines and then try to buy it as cheaply as possible.
Why would someone buy an overvalued stock?
Investing is highly psychological and influenced by current events and by your peers. So you can have a stock that costs, say, 100 cents on the dollar, then 150 cents on the dollar, then 200 cents on the dollar. And people buy it because they see the price going up. But they don’t relate it to what the company is worth. It’s hard to stay really firm because of the pressures from investors that are in your fund and from others. That’s why you need to have the stomach for it.
What’s your take on equities and bonds right now?
Stocks that have been beaten up, like 70 or 80 per cent, I’m looking at because they have come down enough that they are undervalued. And the business prospects are still really good.
Some equities you can buy now, even if they go down like 10 or 20 per cent, you could still make a decent amount of money if you hold on, let’s say, five to 10 years. Eventually, value will win out because you’re buying something that is worth more than what you’re paying for it. As long as your valuation is correct, it will work out fine.
As for bonds, a lot of them have dropped 20 to 30 per cent this year. But I want them to drop even more so when I buy them, I have a huge cushion, a huge margin of safety. If I don’t find any mispriced bonds, or undervalued bonds, I’ll just stay in cash until I find something. As interest rates go up, it’s benefiting us to be in cash.
You seem optimistic about the future.
Yes, as long as I find reasonably good companies and I can buy them at a reasonably good discount, I’m really happy about it. The future will take care of itself.
This interview has been edited and condensed. An extended version is available online