Fund manager Francis Chou used to repair telephones for a living. Back in 1981, with little more than a Grade 12 education, the self-taught value investor convinced seven of his Bell co-workers to invest $51,000 in the Chou Associates Fund. Today, that fund has more than $100 million in assets and boasts a 10-year annual compounded rate of return of 16.7%. As president of Toronto based Chou Associates Management Inc., the native of Allahabad, India, also runs the Chou RRSP Fund, which has done as well as the Associates Fund this past decade. For his long-term investing performance, the Canadian Investment Awards named Chou the Morningstar Fund Manager of the Decade in December.
Canadian Business: What are some of your investment principles?
I rely on a margin of safety, a principle so profound that I made my returns despite making so many bloody mistakes along the way. Simply put, if a company is worth a $100, you buy it for $50 when it's priced that way for some short-term reason.
What kinds of things contribute to a company's margin of safety?
For most companies, a decent balance sheet. You won't have a margin of safety if a company has a lot of debt–no greater than say 25% of total capital should come from fixed instruments like bank debt. You want companies that can generate decent margins on a regular basis, at least 10% pre-tax. If a company is CRAP [cannot realize a profit], then you buy it for very, very cheap–say below net-net working capital [current assets minus current liabilities, long-term debt and preferred shares]. Then there's the qualitative stuff: the quality and stability of management, how long the company has been in business, the economics of the business, the sustainability of earning power.
Your preference is to buy outstanding companies at average prices. Can you think of any recent examples?
In the past, we bought Progressive, which is a great American insurance company. The industry was under a cloud at that time, so investors dumped all the insurance companies, including the good ones. In Canada, we own BMTC Group Inc. and another retailing company, Leon's Furniture Ltd. Leon's is really well run. Both of those companies were neglected because they were small and relatively unknown. These are some of the ways you can get bargains.
Who are your mentors?
Benjamin Graham, without question. Graham's The Intelligent Investor is the only book you need. Read Chapters 8 and 20. Those sections deal with a framework for making decisions. Reading all of Warren Buffett's letters to his Berkshire Hathaway shareholders is also important. Benjamin Graham was more quantitative, so you just do it. What Buffett does require is a little more business experience, because you're identifying both good companies and good management. Once you have the proper framework for making decisions, the rest is easy.
How do you find your investments?
We do a lot of computer screens every month to see which companies are selling cheap. We use criteria like price-to-earnings ratio less than 10, a strong balance sheet. That's how we narrow down 10,000 companies to maybe 50 to 100.
Last year, you launched two new value-oriented funds: the Chou Asia Fund and the Chou Europe Fund. Are international markets a better place to look for bargains these days than the North American markets?
Companies in China look very cheap compared to North American ones for the same company in the same industry. But accounting is very different over there. In general, there's a tendency to hide problems, to save face. As well, China's securities commission is not as advanced as it is here. On the plus side, the country is growing and it's becoming more of a free enterprise. We focus on the better companies and try to buy them cheap. The prices of companies in Europe fall somewhere between Asia and North America. Some countries are cheaper than others. The Netherlands seems cheaper than most.
Your Associates and RRSP funds have generated returns in the high teens over the past 10 years. Why are you telling your investors to expect single-digit returns in the future?
The indices are not cheap. Companies are not cheap. Right now, investors should focus on return of capital. In other words, preserving your money.
What's the best piece of investing advice you've picked up?
Principle will always pull you through. Individual stocks are not important. You can look at value investors going back 50, even 70 years. They all made double-digit returns if they stuck to their principles.