It is “hard work” finding hidden “dirt cheap” value, explains Irwin Michael, president of I.A. Michael Investment Counsel Ltd. and manager of the ABC Fundamental-Value Fund. Through patient spade-work he unearths value buried deep in corporate balance sheets. He focuses on areas less trodden: under–researched, often small–capitalization companies. To date, his hard work has paid off handsomely for investors but challenges persist.

Michael’s value proposition is straightforward: “We want, essentially, to buy you a toonie for a loonie,” he explains. This research-intensive fundamental-value strategy is summarized in his Ten Principles of Value Investing™—what he jokingly calls his “Ten Commandments.” These are the familiar value truisms of a sound business with competent management, “dirt cheap” by a variety of metrics but with some catalyst for realizing intrinsic value.

Value often centers on his assessment of a company’s book value, the theoretical value of tangible assets. “You’ve got to look at ‘book value’ with a sharp scalpel, and you’ve got to carve off a lot of things that are kind of airy-fairy (like good will)” as well as a host of hidden liabilities. On the other hand, there can be hidden assets like, for example, property purchased decades ago and still assessed at the original purchase price. But the “digging” required is “hard work,” he concludes.

Greater opportunities exist for Michael when companies are not well covered by analysts. “A lot of the value, where the market is either misinterpreted or misjudged or not calculated properly, tends to be in companies that aren’t covered and tends to be in companies that are just too small.” He points out, for instance, that 45 percent of public US companies are not followed by a single analyst.

The markets are in fact imperfect, he concludes, “and a lot of companies that are simply not followed present incredible opportunities—for those people who’ve got stamina—but you’ve really got to belly up to the bar, you’ve got to buy it.” The companies are “ripe for opportunity,” as he puts it: “in many cases, they’re diamonds in the rough.” Under this rubric are found his consumer-products picks, Andres Wines Ltd. and Arbor Memorial Services.

These days, however, Michael is finding tremendous value opportunities on the beaten track, in oil and materials stocks, apparently trading at significant discounts to fair market value. He has been holding Nexen Inc. and Talisman Energy for about 4-5 years, he points out; and he is not about to sell, since they still offer value.

Yet after such a strong run for these companies, the low-hanging fruit has already been picked, he cautions, so he is concentrating on actual production and above all cash flow—“we love cash flow.” For this reason, he really likes the fully integrated junior Hudbay Minerals Inc., a junior bound to gravitate to larger-cap, he opines.

Stand back and look at the big picture, he says: Nexen, Canadian Natural Resources, Taliusman and EnCana are takeover targets. “I think you just need one to be taken out, and they’re all going to be taken out,” he enthuses, “… in particular I think Nexen and Talisman are sitting ducks to be taken out by a major: they’re fundamentally very cheap.”

These takeover opportunities also present a challenge for Michael. It is getting harder for Michael to find overlooked value stocks because the Canadian market is shrinking due to consolidation. Accordingly, he is “gradually” ramping up foreign content—gradually, he insists, so as not to abandon his proven metrics and discipline.

Take life insurance companies, for example. While the Canadian sector has been whittled down to three major players, he says, the US remains “very fragmented,” leaving his four or five American lifeco’s “sitting ducks” for take-outs. But, he reiterates, you have to be “patient.”

So far, he has ramped up his American securities to about a fifth of his overall portfolio. He isn’t hedging the US dollar, however: he finds it both “stressful” and “expensive” (in the sense of being a pain to manage forwards). His rationalization runs as follows: if he can get 30-50% returns with a 5-10% currency loss, he’s more than willing to do it. “I am willing to give up a rook to steal a queen,” as he pithily puts it.

The other major risk to his portfolio is his small-cap bias. (Notice that liquidity is therefore an issue. “Because we are a deep-value buyer, I need clients who are in for the long haul.” Greater opportunity translates into least liquidity. “If you’re giving me your kitchen money, I don’t want it.” Accordingly, there is a minimum investment of $150 000 on his open-ended funds.) Thus, 1998 was his worst year because small-caps didn’t recover in time from the Asian Flu. He concedes it can be a “double-edged sword with small-caps”: the danger of being in early, generally.

“If we have a weakness,” Michael summarizes, “[it’s that] we buy early and sell early. We always leave a bit of money on the table.” This weakness, however, has actually been his strength through market downturns. In Michael’s own words: “Better to be a year early than a day late.”