Francis Chou is arguably the only staunch Graham-and-Dodd value investor in Canada today. I say “staunch” because both the concept and application of value investing have become diluted over the years since Benjamin Graham fathered the philosophy in 1949’s The Intelligent Investor. Benjamin Graham would seek out and buy a dollar’s worth of tangible assets for 50 cents. Value investing has evolved, though, because tangible assets are not as prevalent in companies today as they were in the decades from 1890 to 1980, when industrial, transportation, chemical, steel, textile, and oil and gas companies represented the majority of the stock market.
Today, an investor cannot simply “buy a dollar’s worth of assets for 50 cents,” since most companies that make up the stock market do not consist entirely of tangible assets, but rather, to a greater extent, intangible assets. Intangible assets include — but are not limited to — trademarks, copyrights, patents, and brands. Notable examples of predominant intangible companies are Google, Apple, or Microsoft. Success as a Graham-style value investor in today’s market is limited because intangible assets do not hold the same value nor do they produce the same predictable returns as tangible assets. For example, Graham could quite easily and confidently calculate the liquidation value of a steel manufacturer’s machinery and equipment based on readily available market prices, as one key input to determine the worth of that company. From there, he would invest in that steel manufacturer if, say, its price was lower than its net current asset value (current assets less total liabilities). But how do you calculate Microsoft’s worth when intangible assets make up the majority of its business? Think about it, the value of intangible assets can be transitory in that they often do not stand the test of time from the effects of innovation or competition. Even Benjamin Graham, late in his career, declared, “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook Graham and Dodd was first published, but the situation has changed a great deal since then.”
Given today’s reality, Francis Chou has still been able to successfully apply the same Graham-and-Dodd value investing principle to his security selection in both tangible- and intangible-asset-based companies. Using as an example Warren Buffett, who went from being a staunch Graham value disciple to more of a growth at a reasonable price investor, I asked Francis whether he’s ever felt the need to change, to which he replied, “As my knowledge of businesses has grown, I’ve bought good companies as well as mediocre companies. I’m all over the place — wherever I can find bargains.” While deep-value investing represents the core of Francis’s philosophy, he’s complemented his funds with other securities, ones that do not fit into a “deep value” category.
Francis was a 25-year-old repairman for Bell Canada when he pooled $51,000 from himself and six coworkers to start an investment club. That investment club would eventually blossom into Chou Associates Management Inc., which now has around $1 billion of assets under management. The flagship Chou Associates Fund has boasted a long-running and consistent track record since its inception in 1986. Francis sent me Bloomberg screenshots of the Chou Associates Fund’s 15- and 20-year annual compound returns. Fifteen-year compound annual return: 11.69% versus S&P 500’s 4.23%. Twenty-year compound annual return: 13.19% versus S&P 500’s 9.81%.
Both Bloomberg screens were fascinating. The 20-year chart showed the Chou Associates Fund trailing the S&P 500 from 1995 to 2001, during the technology bubble, then vastly outpacing it from 2001 to 2015. Value investing won. Morningstar has shown that the Chou Associates Fund has achieved the highest return of all Canadian mutual funds between 1986 and 2015. Amazingly, Francis achieved the highest returns over this long period with one of the lowest standard deviations in the industry, meaning that his fund experienced only minor volatility or ups and downs. Therefore, the Chou Associates Fund actually ranks the highest according to the Sharpe ratio of portfolio risk-adjusted returns. Using his fund as an example, Francis will often say that the Modern Portfolio Theory (MPT) is bunk. “MPT says that to get high returns, your standard deviation has to be higher; however a positive correlation between risk and return is not found here [in my funds].”
Francis’s was the most challenging interview to secure for this book. It took a letter, multiple phone calls, and multiple emails to both him and his assistant to finally schedule our talk. Francis told me, “You can get all of this information from my annual report” or “Go use what’s been written on me online.” However, I pleaded with Francis that those resources would not suffice, as I needed to produce an in-depth, informal, and entertaining interview. Finally, I got the interview. And trust me, it was worth it.
Francis’s office is located north of Toronto, far removed from Bay Street. It’s just him and his assistant, Stephanie, who work in the office, an office so spare that you could probably fit everything in it into one box. Francis is definitely not an accumulator of things, and he is the embodiment of a successful value investor. This tells you that all you really need to invest is a computer, account, and good ideas.
There is a tinge of sarcastic humour to some of what Francis says. At times, you’ll need to read between the lines, and his humour may not always come through on the first read. Also, occasionally during our interview, Francis would expect me to answer some of his questions. He asked me, “What’s the most important thing to check in the bank?” to which I incorrectly answered, “ROE.” He turned me, the interviewer, into the interviewee. To find out what I should have said, and to learn from a value investing master, you will have to read the interview.
Bargain: a term usually used by value investors to denote a value stock.
Business Moat: the illustration of competitive advantage, which is usually created by strong brands, unique assets, long-term contracts, market position, or some combination of all of these factors.
Dollar-Cost Averaging: when investors continue to put money into a stock while its price on the market declines, either to reduce the average purchase price (and limit their loss), and/or to buy more when it’s cheaper, signifying a value stock opportunity.
Intangibles: non-physical assets, such as brand, that cannot be easily or accurately quantified by accountants and can be subject to depreciation-based changes in perception alone in some cases, or write-downs on erroneous acquisitions (i.e., “Goodwill”) from the past that did not realize an ample return.
Modern Portfolio Theory (MPT): a systematic approach to portfolio diversification based on asset class allocation (e.g., bonds, stocks, etc.), that seeks to maximize return for a given amount of risk in one’s portfolio.
Quantitative Easing (QE): when a central bank (e.g., U.S. Federal Reserve) creates new money to buy financial assets, most commonly bonds, in order to influence higher private sector spending and to meet the designated inflation target during recessions or downturns in the economy.
Valuation: the worth of a company or asset.