(Image: Zen Buddha Silence by Marilyn Barbone.)
August 18, 2019
There’s Always Something to Do: The Peter Cundill Investment Approach, by Christopher Risso-Gill (2011), is an excellent book. Cundill was a highly successful deep value investor whose chosen method was to buy stocks below their liquidation value.
Here is an outline for this blog post:
- Peter Cundill
- Getting to First Base
- Launching a Value Fund
- Value Investment in Action
- Going Global
- A Decade of Success
- Investments and Stratagems
- Learning From Mistakes
- Entering the Big League
- There’s Always Something Left to Learn
- Pan Ocean
- Fragile X
- What Makes a Great Investor?
- Glossary of Terms with Cundill’s Comments
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It was December in 1973 when Peter Cundill first discovered value investing. He was 35 years old at the time. Up until then, despite a great deal of knowledge and experience, Cundill hadn’t yet discovered an investment strategy. He happened to be reading George Goodman’s Super Money on a plane when he came across chapter 3 on Benjamin Graham and Warren Buffett. Cundill wrote about his epiphany that night in his journal:
…there before me in plain terms was the method, the solid theoretical back-up to selecting investments based on the principle of realizable underlying value. My years of apprenticeship were over: ‘THIS IS WHAT I WANT TO DO FOR THE REST OF MY LIFE!’
What particularly caught Cundill’s attention was Graham’s notion that a stock is cheap if it sells below liquidation value. The farther below liquidation value the stock is, the higher the margin of safety and the higher the potential returns. This idea is at odds with modern finance theory, according to which getting higher returns always requires taking more risk.
Peter Cundill became one of the best value investors in the world. He followed a deep value strategy based entirely on buying companies below their liquidation values.
We do liquidation analysis and liquidation analysis only.
GETTING TO FIRST BASE
One of Cundill’s first successful investments was in Bethlehem Copper. Cundill built up a position at $4.50, roughly equal to cash on the balance sheet and far below liquidation value:
Both Bethlehem and mining stocks in general were totally out of favour with the investing public at the time. However in Peter’s developing judgment this was not just an irrelevance but a positive bonus. He had inadvertently stumbled upon a classic net-net: a company whose share price was trading below its working capital, net of all its liabilities. It was the first such discovery of his career and had the additional merit of proving the efficacy of value theory almost immediately, had he been able to recognize it as such. Within four months Bethlehem had doubled and in six months he was able to start selling some of the position at $13.00. The overall impact on portfolio performance had been dramatic.
Riso-Gill describes Cundill as having boundless curiosity. Cundill would not only visit the worst performing stock market in the world near the end of each year in search of bargains. But he also made a point of total immersion with respect to the local culture and politics of any country in which he might someday invest.
LAUNCHING A VALUE FUND
Early on, Cundill had not yet developed the deep value approach based strictly on buying below liquidation value. He had, however, concluded that most models used in investment research were useless and that attempting to predict the general stock market was not doable with any sort of reliability. Eventually Cundill immersed himself in Graham and Dodd’s Security Analysis, especially chapter 41, “The Asset-Value Factor in Common-Stock Valuation,” which he re-read and annotated many times.
When Cundill was about to take over an investment fund, he wrote to the shareholders about his proposed deep value investment strategy:
The essential concept is to buy under-valued, unrecognized, neglected, out of fashion, or misunderstood situations where inherent value, a margin of safety, and the possibility of sharply changing conditions created new and favourable investment opportunities. Although a large number of holdings might be held, performance was invariably established by concentrating in a few holdings. In essence, the fund invested in companies that, as a result of detailed fundamental analysis, were trading below their ‘intrinsic value.’ The intrinsic value was defined as the price that a private investor would be prepared to pay for the security if it were not listed on a public stock exchange. The analysis was based as much on the balance sheet as it was on the statement of profit and loss.
Cundill went on to say that he would only buy companies trading below book value, preferably below net working capital less long term debt (Graham’s net-net method). Cundill also required that the company be profitable—ideally having increased its earnings for the past five years—and dividend-paying—ideally with a regularly increasing dividend. The price had to be less than half its former high and preferably near its all time low. And the P/E had to be less than 10.
Cundill also studied past and future profitability, the ability of management, and factors governing sales volume and costs. But Cundill made it clear that the criteria were not always to be followed precisely, leaving room for investment judgment, which he eventually described as an art form.
Cundill told shareholders about his own experience with the value approach thus far. He had started with $600,000, and the portfolio increased 35.2%. During the same period, the All Canadian Venture Fund was down 49%, the TSE industrials down 20%, and the Dow down 26%. Cundill also notes that 50% of the portfolio had been invested in two stocks (Bethlehem Copper and Credit Foncier).
About this time, Irving Kahn became a sort of mentor to Cundill. Kahn had been Graham’s teaching assistant at Columbia University.
VALUE INVESTMENT IN ACTION
Having a clearly defined set of criteria helped Cundill to develop a manageable list of investment candidates in the decade of 1974 to 1984 (which tended to be a good time for value investors). The criteria also helped him identify a number of highly successful investments.
For example, the American Investment Company (AIC), one of the largest personal loan companies in the United States, saw its stock fall from over $30.00 to $3.00, despite having a tangible book value per share of $12.00. As often happens with good contrarian value candidates, the fears of the market about AIC were overblown. Eventually the retail loan market recovered, but not before Cundill was able to buy 200,000 shares at $3.00. Two years later, AIC was taken over at $13.00 per share by Leucadia. Cundill wrote:
As I proceed with this specialization into buying cheap securities I have reached two conclusions. Firstly, very few people really do their homework properly, so now I always check for myself. Secondly, if you have confidence in your own work, you have to take the initiative without waiting around for someone else to take the first plunge.
…I think that the financial community devotes far too much time and mental resource to its constant efforts to predict the economic future and consequent stock market beaviour using a disparate, and almost certainly incomplete, set of statistical variables. It makes me wonder what might be accomplished if all this time, energy, and money were to be applied to endeavours with a better chance of proving reliable and practically useful.
Meanwhile, Cundill had served on the board of AIC, which brought some valuable experience and associations.
Cundill found another highly discounted company in Tiffany’s. The company owned extremely valuable real estate in Manhattan that was carried on its books at a cost much lower than the current market value. Effectively, the brand was being valued at zero. Cundill accumulated a block of stock at $8.00 per share. Within a year, Cundill was able to sell it at $19.00. This seemed like an excellent result, except that six months later, Avon Products offered to buy Tiffany’s at $50.00. Cundill would comment:
The ultimate skill in this business is in knowing when to make the judgment call to let profits run.
Sam Belzberg—who asked Cundill to join him as his partner at First City Financial—described Cundill as follows:
He has one of the most important attributes of the master investor because he is supremely capable of running counter to the herd. He seems to possess the ability to consider a situation in isolation, cutting himself off from the mill of general opinion. And he has the emotional confidence to remain calm when events appear to be indicating that he’s wrong.
Partly because of his location in Canada, Cundill early on believed in global value investing. He discovered that just as individual stocks can be neglected and misunderstood, so many overseas markets can be neglected and misunderstood. Cundill enjoyed traveling to these various markets and learning the legal accounting practices. In many cases, the difficulty of mastering the local accounting was, in Cundill’s view, a ‘barrier to entry’ to other potential investors.
Cundill also worked hard to develop networks of locally based professionals who understood value investing principles. Eventually, Cundill developed the policy of exhaustively searching the globe for value, never favoring domestic North American markets.
A DECADE OF SUCCESS
Cundill summarized the lessons of the first 10 years, during which the fund grew at an annual compound rate of 26%. He included the following:
- The value method of investing will tend at least to give compound rates of return in the high teens over longer periods of time.
- There will be losing years; but if the art of making money is not to lose it, then there should not be substantial losses.
- The fund will tend to do better in slightly down to indifferent markets and not to do as well as our growth-oriented colleagues in good markets.
- It is ever more challenging to perform well with a larger fund…
- We have developed a network of contacts around the world who are like-minded in value orientation.
- We have gradually modified our approach from a straight valuation basis to one where we try to buy securities selling below liquidation value, taking into consideration off-balance sheet items.
- THE MOST IMPORTANT ATTRIBUTE FOR SUCCESS IN VALUE INVESTING IS PATIENCE, PATIENCE, AND MORE PATIENCE. THE MAJORITY OF INVESTORS DO NOT POSSESS THIS CHARACTERISTIC.
INVESTMENTS AND STRATAGEMS
Buying at a discount to liquidation value is simple in concept. But in practice, it is not at all easy to do consistently well over time. Peter Cundill explained:
None of the great investments come easily. There is almost always a major blip for whatever reason and we have learnt to expect it and not to panic.
Although Cundill focused exclusively on discount to liquidation value when analyzing equities, he did develop a few additional areas of expertise, such as distressed debt. Cundill discovered that, contrary to his expectation of fire-sale prices, an investor in distressed securities could often achieve large profits during the actual process of liquidation. Success in distressed debt required detailed analysis.
LEARNING FROM MISTAKES
1989 marked the fifteenth year in a row of positive returns for Cundill’s Value Fund. The compound growth rate was 22%. But the fund was only up 10% in 1989, which led Cundill to perform his customary analysis of errors:
…How does one reduce the margin of error while recognizing that investments do, of course, go down as well as up? The answers are not absolutely clear cut but they certainly include refusing to compromise by subtly changing a question so that it shapes the answer one is looking for, and continually reappraising the research approach, constantly revisiting and rechecking the detail.
What were last year’s winners? Why?—I usually had the file myself, I started with a small position and stayed that way until I was completely satisfied with every detail.
For most value investors, the investment thesis depends on a few key variables, which should be written down in a short paragraph. It’s important to recheck each variable periodically. If any part of the thesis has been invalidated, you must reassess. Usually the stock is no longer a bargain.
It’s important not to invent new reasons for owning the stock if one of the original reasons has been falsified. Developing new reasons for holding a stock is usually misguided. However, you need to remain flexible. Occasionally the stock in question is still a bargain.
ENTERING THE BIG LEAGUE
In the mid 1990’s, Cundill made a large strategic shift out of Europe and into Japan. Typical for a value investor, he was out of Europe too early and into Japan too early. Cundill commented:
We dined out in Europe, we had the biggest positions in Deutsche Bank and Paribas, which both had big investment portfolios, so you got the bank itself for nothing. You had a huge margin of safety—it was easy money. We had doubles and triples in those markets and we thought we were pretty smart, so in 1996 and 1997 we took our profits and took flight to Japan, which was just so beaten up and full of values. But in doing so we missed out on some five baggers, which is when the initial investment has multiplied five times, and we had to wait at least two years before Japan started to come good for us.
This is a recurring problem for most value investors—that tendency to buy and to sell too early. The virtues of patience are severely tested and you get to thinking it’s never going to work and then finally your ship comes home and you’re so relieved that you sell before it’s time. What we ought to do is go off to Bali or some such place and sit in the sun to avoid the temptation to sell too early.
As for Japan, Cundill had long ago learned the lesson that cheap stocks can stay cheap for “frustratingly long” periods of time. Nonetheless, Cundill kept loading up on cheap Japanese stocks in a wide range of sectors. In 1999, his Value Fund rose 16%, followed by 20% in 2000.
THERE’S ALWAYS SOMETHING LEFT TO LEARN
Although Cundill had easily avoided Nortel, his worst investment was nevertheless in telecommunications: Cable & Wireless (C&W). In the late 1990’s, the company had to give up many of its networks in newly independent former British colonies. The shares dropped from 15 pounds per share to 6 pounds.
A new CEO, Graham Wallace, was brought in. He quickly and skillfully negotiated a series of asset sales, which dramatically transformed the balance sheet from net debt of 4 billion pounds to net cash of 2.6 billion pounds. Given the apparently healthy margin of safety, Cundill began buying shares in March 2000 at just over 4 pounds per share. (Net asset value was 4.92 pounds per share.) Moreover:
[Wallace was] generally regarded as a relatively safe pair of hands unlikely to be tempted into the kind of acquisition spree overseen by his predecessor.
Unfortunately, a stream of investment bankers, management consultants, and brokers made a simple but convincing pitch to Wallace:
the market for internet-based services was growing at three times the rate for fixed line telephone communications and the only quick way to dominate that market was by acquisition.
Wallace proceeded to make a series of expensive acquisitions of loss-making companies. This destroyed C&W’s balance sheet and also led to large operating losses. Cundill now realized that the stock could go to zero, and he got out, just barely. As Cundill wrote later:
… So we said, look they’ve got cash, they’ve got a valuable, viable business and let’s assume the fibre optic business is worth zero—it wasn’t, it was worth less than zero, much, much less!
Cundill had invested nearly $100 million in C&W, and they lost nearly $59 million. This loss was largely responsible for the fund being down 11% in 2002. Cundill realized that his investment team needed someone to be a sceptic for each potential investment.
In late 2002, oil prices began to rise sharply based on global growth. Cundill couldn’t find any net-net’s among oil companies, so he avoided these stocks. Some members of his investment team argued that there were some oil companies that were very undervalued. Finally, Cundill announced that if anyone could find an oil company trading below net cash, he would buy it.
Cundill’s cousin, Geoffrey Scott, came across a neglected company: Pan Ocean Energy Corporation Ltd. The company was run by David Lyons, whose father, Vern Lyons, had founded Ocelot Energy. Lyons concluded that there was too much competition for a small to medium sized oil company operating in the U.S. and Canada. The risk/reward was not attractive.
What he did was to merge his own small Pan Ocean Energy with Ocelot and then sell off Ocelot’s entire North American and other peripheral parts of the portfolio, clean up the balance sheet, and bank the cash. He then looked overseas and determined that he would concentrate on deals in Sub-Saharan Africa, where licenses could be secured for a fraction of the price tag that would apply in his domestic market.
Lyons was very thorough and extremely focused… He narrowed his field down to Gabon and Tanzania and did a development deal with some current onshore oil production in Gabon and a similar offshore gas deal in Tanzania. Neither was expensive.
Geoffrey Scott examined Pan Ocean, and found that its share price was almost equal to net cash and the company had no debt. He immediately let Cundill know about it. Cundill met with David Lyons and was impressed:
This was a cautious and disciplined entrepreneur, who was dealing with a pool of cash that in large measure was his own.
Lyons invited Cundill to see the Gabon project for himself. Eventually, Cundill saw both the Gabon project and the Tanzania project. He liked what he saw. Cundill’s fund bought 6% of Pan Ocean. They made six times their money in two and a half years.
As early as 1998, Cundill had noticed a slight tremor in his right arm. The condition worsened and affected his balance. Cundill continued to lead a very active life, still reading and traveling all the time, and still a fitness nut. He was as sharp as ever in 2005. Risso-Gill writes:
Ironically, just as Peter’s health began to decline an increasing number of industry awards for his achievements started to come his way.
For instance, he received the Analyst’s Choice award as “The Greatest Mutual Fund Manager of All Time.”
In 2009, Cundill decided that it was time to step down, as his condition had progressively worsened. He continued to be a voracious reader.
WHAT MAKES A GREAT INVESTOR?
Risso-Gill tries to distill from Cundill’s voluminous journal writings what Cundill himself believed it took to be a great value investor.
Curiosity is the engine of civilization. If I were to elaborate it would be to say read, read, read, and don’t forget to talk to people, really talk, listening with attention and having conversations, on whatever topic, that are an exchange of thoughts. Keep the reading broad, beyond just the professional. This helps to develop one’s sense of perspective in all matters.
Patience, patience, and more patience…
You must have the ability to focus and to block out distractions. I am talking about not getting carried away by events or outside influences—you can take them into account, but you must stick to your framework.
ATTENTION TO DETAIL
Never make the mistake of not reading the small print, no matter how rushed you are. Always read the notes to a set of accounts very carefully—they are your barometer… They will give you the ability to spot patterns without a calculator or spreadsheet. Seeing the patterns will develop your investment insights, your instincts—your sense of smell. Eventually it will give you the agility to stay ahead of the game, making quick, reasoned decisions, especially in a crisis.
… Either [value or growth investing] could be regarded as gambling, or calculated risk. Which side of that scale they fall on is a function of whether the homework has been good enough and has not neglected the fieldwork.
INDEPENDENCE OF MIND
I think it is very useful to develop a contrarian cast of mind combined with a keen sense of what I would call ‘the natural order of things.’ If you can cultivate these two attributes you are unlikely to become infected by dogma and you will begin to have a predisposition toward lateral thinking—making important connections intuitively.
I have no doubt that a strong sense of self belief is important—even a sense of mission—and this is fine as long as it is tempered by a sense of humour, especially an ability to laugh at oneself. One of the greatest dangers that confront those who have been through a period of successful investment is hubris—the conviction that one can never be wrong again. An ability to see the funny side of oneself as it is seen by others is a strong antidote to hubris.
Routines and discipline go hand in hand. They are the roadmap that guides the pursuit of excellence for its own sake. They support proper professional ambition and the commercial integrity that goes with it.
Scepticism is good, but be a sceptic, not an iconoclast. Have rigour and flexibility, which might be considered an oxymoron but is exactly what I meant when I quoted Peter Robertson’s dictum ‘always change a winning game.’ An investment framework ought to include a liberal dose of scepticism both in terms of markets and of company accounts.
The ability to shoulder personal responsibility for one’s investment results is pretty fundamental… Coming to terms with this reality sets you free to learn from your mistakes.
GLOSSARY OF TERMS WITH CUNDILL’S COMMENTS
Here are some of the terms.
There’s almost too much information now. It boggles most shareholders and a lot of analysts. All I really need is a company’s published reports and records, that plus a sharp pencil, a pocket calculator, and patience.
Doing the analysis yourself gives you confidence buying securities when a lot of the external factors are negative. It gives you something to hang your hat on.
I’d prefer not to know what the analysts think or to hear any inside information. It clouds one’s judgment—I’d rather be dispassionate.
I go cold when someone tips me on a company. I like to start with a clean sheet: no one’s word. No givens. I’m more comfortable when there are no brokers looking over my shoulder.
They really can’t afford to be contrarians. A major investment house can’t afford to do research for five customers who won’t generate a lot of commissions.
This started for me when Mutual Shares chieftain Mike Price, who used to be a pure net-net investor, began talking about something called the ‘extra asset syndrome’ or at least that is what I call it. It’s taking, you might say, net-net one step farther, to look at all of a company’s assets, figure the true value.
We don’t do a lot of forecasting per se about where markets are going. I have been burned often enough trying.
Peter Cundill has never been afraid to make his own decisions and by setting up his own fund management company he has been relatively free from external control and constraint. He doesn’t follow investment trends or listen to the popular press about what is happening on ‘the street.’ He has travelled a lonely but profitable road.
‘Being willing to be the only one in the parade that’s out of step. It’s awfully hard to do, but Peter is disciplined. You have to be willing to wear bellbottoms when everyone else is wearing stovepipes.’ – Ross Southam
Mostly Graham, a little Buffett, and a bit of Cundill.
I like to think that if I stick to my formula, my shareholders and I can make a lot of money without much risk.
When I stray out of my comfort zone I usually get my head handed to me on a platter.
I suspect that my thinking is an eclectic mix, not pure net-net because I couldn’t do it anyway so you have to have a new something to hang your hat on. But the framework stays the same.
I used to try and pick the best stocks in the fund portfolios, but I always picked the wrong ones. Now I take my own money and invest it with that odd guy Peter Cundill. I can be more detached when I treat myself as a normal client.
If it is cheap enough, we don’t care what it is.
Why will someone sell you a dollar for 50 cents? Because in the short run, people are irrational on both the optimistic and pessimistic side.
All we try to do is buy a dollar for 40 cents.
In our style of doing things, patience is patience is patience.
One of the dangers about net-net investing is that if you buy a net-net that begins to lose money your net-net goes down and your capacity to be able to make a profit becomes less secure. So the trick is not necessarily to predict what the earnings are going to be but to have a clear conviction that the company isn’t going bust and that your margin of safety will remain intact over time.
MARGIN OF SAFETY
The difference between the price we pay for a stock and its liquidation value gives us a margin of safety. This kind of investing is one of the most effective ways of achieving good long-term results.
If there’s a bad stock market, I’ll inevitably go back in too early. Good times last longer than we think but so do bad times.
Markets can be overvalued and keep getting expensive, or undervalued and keep getting cheap. That’s why investing is an art form, not a science.
I’m agnostic on where the markets will go. I don’t have a view. Our task is to find undervalued global securities that are trading well below their intrinsic value. In other words, we follow the strict Benjamin Graham approach to investing.
Search out the new lows, not the new highs. Read the Outstanding Investor Digest to find out what Mason Hawkins or Mike Price is doing. You know good poets borrow and great poets steal. So see what you can find. General reading—keep looking at the news to see what’s troubled. Experience and curiosity is a really winning combination.
What differentiates us from other money managers with a similar style is that we’re comfortable with new lows.
Many people consider value investing dull and as boring as watching paint dry. As a consequence value investors are not always listened to, especially in a stock market bubble. Investors are often in too much of a hurry to latch on to growth stocks to stop and listen because they’re afraid of being left out…
I don’t just calculate value using net-net. Actually there are many different ways but you have to use what I call osmosis—you have got to feel your way. That is the art form, because you are never going to be right completely; there is no formula that will ever get you there on its own. Osmosis is about intuition and about discipline and about all the other things that are not quantifiable. So can you learn it? Yes, you can learn it, but it’s not a science, it’s an art form. The portfolio is a canvas to be painted and filled in.
When times aren’t good I’m still there. You find bargains among the unpopular things, the things that everybody hates. The key is that you must have patience.
We try not to lose. But we don’t want to try too hard. The losses, of course, work against you in establishing decent compound rates of return. And I hope we won’t have them. But I don’t want to be so risk-averse that we are always trying too hard not to lose.
All I know is that if you can end up with a 20% track record over a longer period of time, the compound rates of return are such that the amounts are staggering. But a lot of investors want excitement, not steady returns. Most people don’t see making money as grinding it out, doing it as efficiently as possible. If we have a strong market over the next six months and the fund begins to drop behind and there isn’t enough to do, people will say Cundill’s lost his touch, he’s boring.
TIMING: “THERE’S ALWAYS SOMETHING TO DO”
…Irving Kahn gave me some advice many years ago when I was bemoaning the fact that according to my criteria there was nothing to do. He said, ‘there is always something to do. You just need to look harder, be creative and a little flexible.’
I don’t think I want to become too fashionable. In some ways, value investing is boring and most investors don’t want a boring life—they want some action: win, lose, or draw.
I think the best decisions are made on the basis of what your tummy tells you. The Jesuits argue reason before passion. I argue reason and passion. Intellect and intuition. It’s a balance.
We do liquidation analysis and liquidation analysis only.
Ninety to 95% of all my investing meets the Graham tests. The times I strayed from a rigorous application of this philosophy I got myself into trouble.
But what do you do when none of these companies is available? The trick is to wait through the crisis stage and into the boredom stage. Things will have settled down by then and values will be very cheap again.
We customarily do three tests: one of them asset-based—the NAV, using the company’s balance sheet. The second is the sum of the parts, which I think is probably the most important part that goes into the balance sheet I’m creating. And then a future NAV, which is making a stab (which I am always suspicious about) at what you think the business might be doing in three years from now.
I’ve been doing this for thirty years. And I love it. I’m lucky to have the kind of life where the differentiation between work and play is absolutely zilch. I have no idea whether I’m working or whether I’m playing.
My wife says I’m a workaholic, but my colleagues say I haven’t worked for twenty years. My work is my play.
BOOLE MICROCAP FUND
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: http://boolefund.com/best-performers-microcap-stocks/
This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.
There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.
The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.
If you are interested in finding out more, please e-mail me or leave a comment.
My e-mail: firstname.lastname@example.org
Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.