This is a summary and interpretation of a lecture on value investing and investing in Japan by the great value investor Peter Cundill. The presentation was held in 2005 at the Ben Graham Centre of Value Investing.
The Video is well worth watching, but unfortunately of very poor quality.
Link:
Mr. Peter Cundill, FCA, CFA, The Cundill Group March 28, 2005
Peter Cundill on Value Investing in Generell
Mr. Cundill came to Value Investing in 1972-73 when reading the Book Supermoney by Adam Smith. There he learned about Graham and Buffett and found out, that buying a stock trading below net cash inevitably worked. He describes the time of 1975 as a wonderful time to do net-net investments. Especially because the economy got better, interest rates stabilized and the various banking crisis began to be solved. He stresses that a stabilizing macro-environment is very important when doing net-net investing. His experience with net-net investments is that for them to become profitable one needs that macro tailwind. Without that you can "turn blue" investing in net-nets.
Also in 1975 he found hundreds of the so called magic sixes: those are stocks with six percent dividend yield; a P/E ratio of six and trading at 60% of book value.
What I personally find the most enlightening in this lecture is Peter Cundill talking about his weaknesses. He sees himself as very inflexible, as he adheres strictly to Graham net-net investing. In contrast to himself, he saw Graham as more flexible. Graham adopted more to circumstances, for example by creating a formula to value growth in the 60´s. He advises to hold it with Sir Tempelton, who once said: always change a winning game. There is no investment methodology that is pristine forever. There are always breaks. The trick to make value investing even more successful is to anticipate those breaks and shift accordingly. But he cautions that it is not the discipline and not the framework that has to be adjusted, but rather the tactics involved.
Although he admits that the entry point of investment is extremely important ("if I had entered into net-nets too early I wouldn't be around (as an investor) anymore“), he sees selling the harder part in value investing. Generally value investor tend to buy too early and sell too early. Interesting to note is that he seems to see selling too early as a strategic mistake.
" (...) Another strategic error was involved in Deutsche Bank and BNP Paribas. They had an industrial share portfolio. You didn't pay anything for the bank, they had a huge margin of safety. We doubled and tripled our money, we did very well. So we did take out our money and went to Japan (…) missed out the five beggars and had to wait a couple of years for Japan to kick in (...)."
" (...) Patients part of it (...) you think this will never work and then your check comes home and you sell before its done (...) I still remember Macony that made radio sets for the US army (...) was almost a net-net bought at 5 sold when it went to 9 (...) than Merill Lynch came out saying it was a growth stock and it went to 55 (...) oh hope (in Japan) it’s going right. Japan has been kind to us; Please god let me(...) not sell before its time (...). "
Regarding the research process of finding value investments he advises to look for new lows; also good are recommendation by someone you know and trust and then dig deeper into the filings; reading the newspaper, especially about what is troubled. Also he deemed as a very good strategy to find out what other great value investors are doing: " (...) Good poets borrow, Great poets steal! (...) " In general he sees experience and curiosity as the winning combination to come up with good investment ideas.
Cundill is very suspicious towards more complex models of valuation. He sees himself not being good enough at math to do DCF. He rather holds it with Graham, e.g. if you can't add it, subtract it, multiply it and divide it, it is too complicated. He sees the main problem with DCF that it tries to make something imprecise into something precise. „ (...) (those models) nice to look at but dangerous as hell because you can over rely on them (...). "
Cundill is not a huge fan of diversification. " (...) in the early 90's we had too many names (...) couldn't follow it (...) now we have 75% of our capital in 25 names mostly Asian, mostly Japan but not all (...) we became more concentrated over time (...). "
On the question if value investing can be learned, Cundill replies: " (...) yes, but they have to have a feel for it (...) you can learn it, but it’s not a science it is an art form (...) to find the intrinsic value of a company you have to feel your way, that is the art form of the value investing business. There is no formula (...). "
He has an anecdote about a guy he has money with and who is an absolute (strict) Graham and Dodd net-net investor " (...) he is going nowhere, because he is too rigid (...)."
Peter Cundill on Investing in Japan
" (...) how beaten up the Japanese market is; topping at 40´000 in 1989 and now trading at roughly 12´000. What an incredible compound rate of loss! (...) "
In 1997 Peter Cundill was the first major value investor to venture into value investing in Japan after the bubble had burst in 1989. What I really found striking is that Cundill had already invested in Japan around 1985, when the bubble in Japan was starting to come into full swing.
People in Japan were surprised seeing Cundill to invest in Japanese equities during that time, as the market was already deemed expensive by many money managers. But not so by Cundill. He argued that, including the huge investment portfolios of many Japanese companies, you could find net- net investments. He backed out of his positions in 1988 and started shorting, as he now saw valuations getting really stretched.
In 1997 he pulled out of his European investments to start investing in Japan again. The reason he ventured into Japanese equities once more was, that there were hundreds of net-nets and they were pure net-nets, e.g. trading below cash, had no debt and made some kind of money. Also he saw the extraordinary situation of very large foreign shareholdings in Japanese companies. He thought that in Japan maybe hostile takeover bits would help him on the very cheap stocks. He was wrong. Many of his investments turned out to be value traps. One reason was management not being very open to recommendations, e.g. paying out/ increasing dividends or buying back share: " (...) they didn't have to because of cross shareholding. (...) (The Investors) were fighting city hall and they didn't now they were fighting city hall. (...) "
Those Value traps didn't stay net-nets forever, but sometimes it felt like being forever. So he cautions that „ (...) you have to have a sense about a catalyst (owner on your side, takeover bid, merger) otherwise they are hide bound forever, it isn't but it can seem like forever (...)".
He sees a lot of changes in Japan’s corporate landscape. Especially a process of much better corporate governance. Corporate Japan is buying back shares and paying dividends and there are hostile takeovers and activist approaches to Japanese companies lately. He is especially excited about activism undertaken by young Japanese." (...) foreign investors have been making suggestions, but the real war has been conducted by Japanese on their own (...) it's Japanese against Japanese, it’s terrific (...) if I was a Japanese manager, I wouldn't be scared about foreigners but rather about young Japanese (...)."
Regarding the research process to find interesting Japanese stocks, he says that " (...) net-net sheets in Japan need more manual work than the US or the English ones (...). "
Value Investing in Japan and Beyond
The video is very insightful and worth watching. The value investing community lost an outstanding member when Peter Cundill died in 2011.
Points he made worth taking note of:
Although being a bottom up investor he seems to have at least an eye on the overall macro picture of the country he invests in. He sees an improvement of the macroeconomic to be extremely helpful in shortening the time frame of his investments finally playing out.
Furthermore, regarding investing in Japan and coming up with a Japanese net-net sheet he stresses that more manual work is needed than in the US and UK. I couldn't agree more. You are not going to find the "hidden gems" in Japan with only doing a computer screen. People will miss out on the most interesting situations, when trying to avoid the tedious work of digging into the annual reports.
Also I do share his excitement about potential activism in Japan coming from within Japan. There were encouraging signs in 2005 that this phenomenon could gain momentum. Unfortunately it didn't! And as far as I can see it there is little to no indication of young Japanese having a second try on activism in their country for the time being.
Having said that, one has to stress that the observed trend by Peter Cundill of corporate Japan's attitude towards increased returns (share buybacks; increased dividends) to their shareholder's has been gaining momentum with many Japanese companies. I am pretty sure that Cundill would have been as pleased with and encouraged by those developments as I am.
Finally and most importantly, Cundill’s general remarks about value investing can appear to be a bit inconsistent and confusing at first glance. With Cundill you have a highly successful disciple of Graham and Dodd`s approach to investing, with an impressive long-term track record. It seems that he managed to achieve those results by strictly adhering to the principles of net-net investing, e.g. mostly investing in cigar but like investment situations. But at the lecture he stresses that his rigidity had also been his biggest weakness. He also sees the rigidity of the money manager he delegated money to as the main reason for his (temporary?) lack of success. And, last but not least, one of his biggest "nightmares" seems to be to sell a position too early.
But doesn't the disciplined approach demands to liquidate the position of a net-net investment when the discount to NCAV disappears?
How do those remarks by Cundill fit with the template developed by Graham and Dodd concerning investments in Net-net stocks?
I can only guess. I am inclined to say that in order to make any sense out of this apparent "contradictions", the "art aspect" of value investing does come into play here. And that this aspect of value investing is especially important when it comes to selling a holding.
Let me explain. I doubt very much that he intended to get the last out of the stock, e.g. taking part in the mature momentum gains of the stock. But rather to get out the most in terms of adjustment of the stock to intrinsic value. When one initiates a position in a (net-net) stock, the intrinsic value (or more precisely the discount to intrinsic value, with the intrinsic value being a residual of this valuation process) is almost exclusively derived from the tangible book value (mainly the net liquid asset position). But the balance sheet is just a snapshot of the (Asset/ Financial) state of the business at exactly that point of time. And so is the intrinsic value (or discount to), e.g. it is static (rigid). But as time goes by profits are made or losses incurred, cash is generated or cash is burned; in short the quantitative readings of a business are impacted and hence its intrinsic value. And more importantly, old management goes and new management comes, strategic shifts are taking place concerning the treatment of shareholders and/ or the conduct of business, having an material impact on payout ratios and/ or ability to monetize on the company's asset base and thus impacting the intrinsic value significantly too.
Getting down to the nitty- gritty. The Graham and Dodd approach to net-net investing and intrinsic value is static (e.g. rigid). But intrinsic value has also got a dynamic dimension. The art of selling and value investing is to see (or even better to anticipate) the shifts in the investment case and intrinsic value and act (or decide not to act) accordingly (e.g. being flexible).
The static part of value investing is the science and the flexible part the art.
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