By his own admission, deep value investor Francis Chou is dismayed by the lack of bargains in the marketplace. As a result of his insistence on buying stocks when they are trading at 40% to 50% discounts, he's sitting on lots of cash. Specifically, there's 25% in the $145.7-millionChou Associates and 44% in the $133.4-millionChou RRSP, both of which he has managed since inception in October 1986.
"Stocks are very expensive. You have to be very careful these days," says Chou, 48, president of Toronto-based Chou Associates Management Inc. "But I'm waiting for the market to break, so we can put our cash to work." Managing the funds in his spare time -- he is also vice-president at Toronto-based Fairfax Financial Corp., where he helps run the insurer's investment portfolio -- Chou scrutinizes more than 2,000 stocks around the world. He discards more than 80% because they are trading at high multiples, or fail to meet certain financial ratios. That leaves about 400 stocks that he monitors closely.
Chou likes companies that have sustainable long-term returns on equity of more than 15%, excellent management control over receivables, inventory and fixed assets, and low debt-equity ratios. He then buys companies that are out of favour and trading at deep discounts.
"You use a set of criteria to find out what a company is worth. If it's worth $100, you try to buy it at $50, or $60," says Chou. "The goal is to come to an assessment of what the company might be sold for."
Chou is extremely picky, holding only about 25 names in his funds. Single portfolio positions currently run as high as 10%, although they are usually kept to about 2% to 3%. He will keep some positions for several years, and his annual portfolio turnover is about 25% to 30%.
A case in point is the Federal Home Loan Mortgage Corp., or Freddie Mac ( FRE/NYSE). He acquired that name in 1990 at about US$3, but sold out in 2003 at about US$50 when the insurer's balance sheet became too murky for his liking. "They may continue to do well," he wrote in the 2003 annual report, "but the shares were sold because I didn't have the confidence to properly assess their financial liabilities."
While firmly planted in the investment world, Chou came to it in an unconventional way. He was born in India and immigrated to Canada in 1976 with $200 in his pocket. Initially, he worked at Bell Canada as a technician. But in the late 1970s he became interested in investing and began studying texts such as Security Analysis by Benjamin Graham, as well as the methodology of Warren Buffet.
In July 1981, he set up an investment club with seven members and $51,000 in capital. By 1986, it had grown to about $1.7 million when the club was converted to Chou Associates. Chou RRSP had similar small beginnings.
Chou left Bell Canada in 1984, and became a retail analyst at Toronto broker Gardiner Watson. After 18 months, he joined Fairfax Financial as one of its original investors. He stayed several months, and then took a lengthy hiatus to run the mutual funds. In 1996, he returned to Fairfax.
The two funds' top quartile performance over the last 15 years has attracted many new investors. Chou RRSP has grown more than eight-fold in size since 2002, when assets were $15.8 million. Similarly, Chou Associates is up seven-fold over the same period. Both funds were the winners in their respective categories at the 2003 Canadian Investment Awards held in December.
Lacking a marketing team, Chou relies on word-of-mouth for sales that are conducted through some discount and full-service brokers. Given Chou RRSP's rate of growth, he may cap it at $200 million. There's no plan to cap the foreign fund.
Last September, Chou introduced two new funds, the $10.5-millionChou Asia and the $3.2-millionChou Europe, both of which still hold about 70% cash.
Chou thrives in bear markets when bargains are abundant. The Morningstar five-star rated funds did extremely well during 2000-2002. "Bear markets are good for value investors," says Chou. "You have the cash to exploit the opportunities. In the meantime, though, you still have to hunt for stocks."
Chou acknowledges that his funds are laggards in the past year and attributes that to his refusal to chase the market. "It's been very problematic for me," he says, in explaining his large cash reserves.
However, Chou remains committed to buying battered or out-of-favour stocks. "If you stick to the principle of value investing, things will work out well for you," he says. "If you breach that principle, it will hurt you badly. It's very simple."
