Finding Deep Value Stocks the Peter Cundill Way

The Magic Sixes

Hello and Good Morning coffee-drinkers!

Today I am going to find new value investment opportunities by combining the strict value approach from Canadian Investor Peter Cundill with the more systematic strategies of What Works on Wall Street.

A letter from Elliott Management has been released and their predictions are gloomy. The letter talked about inflation, de-globalisation, ESG, energy central banks and more and is worth the read and reflects many of the opinions and thoughts that I also have.

Interview with Todd Combs

InvestmentManagementInsight has transcribed the Interview with Todd Combs and I find parts of it fascinating.

Combs recalled the first question Charlie Munger ever asked him was what percentage of S&P 500 businesses would be a “better business” in five years. Combs believed that it was less than 5% of S&P businesses, whereas Munger stated that it was less than 2%. You can have a great business, but it doesn’t mean it will be better in five years. The rate of change in the world is significant, which makes this exercise difficult, but this is something that Charlie, Warren and Todd think about.

This is a great question to think about. There are many exceptional companies. Google is one such example. It has a big competitive advantage in search and Youtube. Yet with the recent ad increases and their other questionable business decisions I don't believe that Google is a better business in a few years. The same can be said about Apple.

If Charlie is right (and more often than not he is) -  that means that only 10 companies in the S&P500 are better businesses in 5 years than they are today. That doesn't mean that the stock price can't go up of the others, but it is important for long term investing to keep this concept in mind.

There's Always Something to Do: The Peter Cundill Investment Approach

I have recently read this book about the Canadian value investor Peter Cundill. He has a few investment approaches that go completely against what was practiced the last few years.

• Buy a stock if it is below liquidation value. Don't use earning forecasting as a primary investment decision.

• Search for companies in the worst performing stock market of the last 11 months.

• Buy undervalued, unrecognized, neglected, out of fashion or misunderstood situations with enough margin of safety (he can't stress the margin of safety part enough).

• Around 10 positions are enough.

• Don't wait for anyone to take the first lunge.

• Bargains are only there on verifiable facts -> so the balance sheet and past earnings.

• "Buy a dollar for 40 cents"

• Always change a winning game. The market always changes and you also have to adapt and change your approach, while keeping proven principles.

Magic Sixes

Peter Cundill found stocks with great return potentials with the following screen.

• Price to Book under 0.6 (P/B < 0.6)

• Dividend Yield over 6% (div yield > 6%)

• Price to Earnings under 6x (P/E < 6)

Furthermore he liked constant earnings growth and like the traditional value investor net-nets. Screening with the criteria above, I get 430 companies on markets that I can access via Interactive Brokers. To tighten the selection, I will also look for companies that have earnings growth and where Current Assets > Total Liabilities. As it is such a big amount, I am rather strict here. As I have no expertise in that field, I remove all REITs and Insurance companies. These companies often offer great value, but are difficult to value if they are in different countries.

Unsurprisingly the majority of the companies are still in Hong Kong and Poland. Current political and macro movements have obviously depressed the prices there. After removing all companies with an EV/EBIT of over 4.0, we are left with 58 companies.

I will also remove companies that have their main operating in Ukraine. For me it is just too hard to know how long this invasion from Russia will continue and what the impacts will be on companies operating there. "Way too hard" pile.

Now I am going to add factors that I learn from "What works on Wall Street"

Return on Equity (RoE) isn't a great indicator of out-performance, but it is of under-performance. The companies that have the worst RoE can't even beat treasury funds adjusted for inflation. I will rank the companies by RoE. If there are extreme jumps in one year to the next, I will just take the average to take cyclicality into account. I will then remove all companies with a lower RoE than 10. That leaves us with 38 companies.

Share-based compensation (SBC) and dilution can reduce the return significantly, so removing companies that dilute you (with the exception of mergers), we are left with 30 companies.

Now comes the discretionary sorting. I will remove the companies, where I know that I have no chance to value them -  even if I do a lot of research. These are mostly steel and iron mining companies.

That leaves me with 18 companies. I will look through them in my next article. So subscribe if you are interested and comment if you have infos about the remaining companies.