Last month, the 2004 Annual Report of the Chou Funds showed up in my e-mail box and I wasted no time in reading his current views on investing. As usual, they were thoughtful, practical, and on-target.
Over the years, I have developed a great respect for a money manager who, until recently, hardly anyone knew about. His name is Francis Chou and, when he isn’t busy with his full-time job as a vice president of Fairfax Financial, he runs a small group of mutual funds that bear his name.
Chou finally received the recognition I have long felt he deserved when he was named Fund Manager of the Decade at the annual Mutual Funds Awards dinner in Toronto last December. But he remains a low-profile individual who rarely makes any public utterances.
That’s why I always await the publication of the annual reports of his funds with anticipation. Of course, they contain the usual numbers but what makes them of special interest are Chou’s pointed comments on the state of the stock markets and investing strategies.
This is the man who wrote at the height of the high-tech bubble: “Let’s not play a fool’s game by thinking that a stock can be bought at 100 times revenues and then proceed to hope, against hope, that someone who is carried away by emotion and is unaware of the risk involved will buy it at 200 times revenues the following week. When the urge hits to take such a leap, take a cold shower until the inclination passes.”
Last month, the 2004 Annual Report of the Chou Funds showed up in my e-mail box and I wasted no time in reading his current views on investing. As usual, they were thoughtful, practical, and on-target. Here are some of the highlights.
Bargains are hard to find . Chou uses a value style of stock selection, based on a margin of safety approach that involves paying less than a company is really worth, based on “sustainable earning power and/or hard assets that are not depreciating in value”. By those standards, he believes that almost all sectors of the market are currently overvalued. “ I cannot remember a time when bargains in general were so scarce,” he writes. “We would caution all investors that from these overvalued levels the chances of a large permanent loss of capital are extremely high. ”
Avoid leveraging . I have always cautioned against using borrowed money to invest except in special circumstances and only then when you understand exactly what you are doing. Chou echoes that warning in his remarks. Quoting John Maynard Keynes, he reminds us: “Whether you are short and the market continues to rise or you are long and the market continues to fall, it is important to remember that the market may well stay irrational longer than a debtor can stay solvent”.
Errors of omission . There are two types of errors when it comes to investing in stocks: omissions and commissions. Commissions are the most common type, typically in the form of a stock purchase that doesn’t work out. Errors of omission are more insidious and potentially even more damaging. They occur “when the stocks you know and understand come down to your bargain price range and yet, for some reason, you defer purchasing them.” He frankly acknowledges that, over the years, errors of this type have been the most painful in terms of running his funds. “Experience has shown us that it is better to purchase certain stocks that meet our margin of safety criteria and risk making a mistake rather than not buy them. There is an opportunity cost involved when you miss buying a bargain that was in your circle of competence. ”
No one is perfect . Even the greatest investor in the world won’t be right all the time. “John Templeton’s investment batting average was about .600, that is, 6 out of 10 stock selections did well. When he retired in 1992, he had one of the best mutual fund records spanning over 40 years.” So don’t be too hard on yourself if you make an occasional bad call. Everyone does it.
There’s a lot more but that gives you the flavour. If you want to read the full report, it’s available on-line at www.choufunds.com
Gordon Pape has published an in-depth analysis of the TD mutual funds, containing reviews and ratings of more than 50 funds. His RBC funds Special Report has also been completely updated. Details at http://www.buildingwealth.ca/promotion/fundslibraryproducts.htm