rotmanmagazine.ca / 53EK: One of the key principles of value investing is
the notion of finding companies — in many cases,
great ones—whose shares appear to be selling at
significant discounts to their intrinsic value. Why
does this happen to a company?
KS:There are numerous reasons, but being over-
looked, under-followed and/or in some kind of
trouble is how I usually think of them. Often, a
management team will stumble in some way —
which is what happened at Empire: They made an acquisition
that should have been terrific, taking them from being mostly
regional to national. It should have been an easy integration,
but it wasn’t; then they misstepped and fired their CEO. This
created an opportunity to buy a good-quality firm without
much debt. If you believe that the company can figure out
how to get back in the saddle, that is an opportunity for sig-
nificant returns in the long-run.
CB:As Kim indicates, there are a lot of reasons
why a company might be under-valued. Dur-
ing the tech bubble of 1999-2000, everyone be-
lieved that, if you didn’t own technology stocks,
you were ‘out of it’. I remember clients calling me and say-
ing, ‘You are finished as an investment manager, because you
don’t own any of this up-and-coming internet stuff.’ And, we
didn’t—because they were outrageously expensive.
Then, suddenly there was so much money going into that
area that the basic fundamental companies were not attract-
ing investment. Even though they were actually doing well,
their stock prices weren’t going up, so there was an unbeliev-
able amount of value there. That’s one example of how you
can find under-valued companies.
Other reasons can be cyclical movements, or as Kim in-
dicates, short-term problems. If you do a deep analysis of a
company that is in trouble, sometimes you can see that the
problem is not going to last forever. For example, Volkswag-
on during its emissions crisis, and BP during the oil-spill de-
bacle. These were horrible, but temporary, situations for re-
ally good companies—and that can provide an opportunity to
buy them below their actual value.
EK: How do you get started on developing a
working list of companies that might fit into the
value class?KS:Today, information is so easy and cheap to ob-
tain. Back in the day, I used to have to pluck num-
bers off of financial statements and enter them into
a computer system; but with today’s tools, we can
basically grind through all of the publicly-listed stocks in the mar-
ketplace. At my firm, we focus in on a formula that relies on clas-
sic value ratios like price of sales, price of cash flow and dividend
yield, and we come up with an intrinsic value; then, we rank the
entire universe according to ‘cheapness’.
Every sector of the market is ‘open season’ for a value in-
vestor — but not always at the same time, because at any point
in time, a stock can stumble. The easy part is finding something
that is cheap; then you have to do the deep analysis to find out
whether it is truly a value candidate. Does it have the appropri-
ate risk characteristics? A lot of times it’s a question of, ‘Can this
stock truly revert back to its mean?’CB:We use the same criterion, as far as starting with
low-priced or ‘unusually-priced’ shares. Then we
look at balance sheets, dividend yield — all of that.
We have analysts divided into eight different indus-
try groups, headed up by 25 senior people. They are responsible
for understanding their industry group and which companies
within it might be potential investments for us. Of course, we
will always be attracted to the worst-performing market in the
world, and we’ll take the time to examine what’s going on there.
We don’t find much anymore in the world’s best-performing
markets.EK: A few years ago, Charles, you talked about
Microsoft as a prime example of great value. Do
you still believe this?CB:A few years back, the Cloud was launched, and
suddenly, Microsoft was considered old-fashioned.
They didn’t own the software market anymore, and
PCs were disappearing. As a result, one of the pre-
mier growth companies in the world got down to about 10 times
earnings — which is the cheapest it had ever been. We looked at it
and said, ‘Wait a minute. Maybe this overall impression that the
PC market is going away is incorrect; Microsoft’s size still gives
it a huge advantage, and its leaders will probably figure out how
to keep up with the Cloud and other developments.’ At the time,
Microsoft was $20 to $30 per share, so we bought it because we
believed it had a future. Today, it’s around $60 a share — so we
would be looking elsewhere for deeper discounts.