On a cold December evening, 35-year old Peter Cundill boarded a flight nursing a monumental hangover. As he settled into the flight, he began to read Super Money, presented to him by a colleague. Within minutes his attention was riveted and he could barely contain his excitement. That night he wrote in his journal:
‘The margin of safety’. It struck me like a thunderbolt – there before me in plain terms was the method, the solid theoretical back-up to selecting investments based on the principle of realizable underlying value.
In his book, There’s Always Something To Do, Christopher Risso-Gill explains why the ‘margin of safety’ concept got Cundill’s attention and why he described it as an epiphany: What was revelatory was surprisingly simple. A share is cheap not because it has a low price earnings multiple, a juicy dividend yield, or a very high growth rate, all of which may often be desirable, but because analysis of the balance sheet reveals that its stock market price is below its liquidation value: its intrinsic worth as a business. This above all is what constitutes “the margin of safety.”
Gill is quick to point out that Cundill was no investment debutant when that happened. In fact, during that period, he was plagued by a growing sense of frustration that at 35 years of age, despite having accumulated considerable business and investment experience, all his efforts to come up with a satisfactory formula that would identify undervalued shares in the stock market with a reasonable degree of safety and consistency seemed to have led him down a series of blind alleys. Hence his eureka moment, when he discovered Benjamin Graham.
Yes, Peter Cundill is a renowned global value investor who in 2001 was presented with the Analysts’ Choice Career Achievement Award. But by no stretch of imagination was he one dimensional. He was also an avid sportsperson, a marathon runner, an extensive traveler and committed philanthropist who lived a flamboyant lifestyle.
Often referred to as the ‘Indiana Jones of Canadian Money Managers', he believed that solid value may be most readily found among what is neglected, unfashionable and apparently boring. He believed that investors tend to follow trends and fashion rather than take the trouble to look for value. Consequently, as a result of the short term mispricing of securities, this offered tremendous opportunity for the professional investment manager.
One such stock was Bethlehem Copper. What caught his attention when he dissected the company’s annual report was that the company had no debt and the shares were actually trading at the price of the cash on the balance sheet. The mining operations were profitable and backed by long-term supply contracts with blue-chip corporations. Cundill started to buy shares at the average cost of $4.50/share when mining stocks and Bethlehem Cooper were totally out of favour with the investing public. At that time, the inexorable rise in the price of copper in response to demand from emerging markets, especially China, had not yet begun. Six months down the road, the fund began to book profits at $13/share.
According to ValueWalk, Cundill Value Fund returned 22% per annum from its launch in 1974 through to 1988. Over its 35 year history to 2010, it achieved a CAGR of 13.7%, which is especially impressive considering that the market was still recovering from the financial crisis when this figure was calculated.
Cundill believed that once the analysis is complete and you have reached the firm conviction that an investment is right, don't try to be too clever about the purchase price.
One of Cundill Value Fund’s first investments was J. Walter Thompson, or JWT, an advertising agency. The company went public in 1972 at more than $20/share. During the recession of the 1970s, the advertising industry was hit hard, more than most other industries. JWT sank to around $4/share. Cundill saw that it was profitable, paid a dividend, and had a book value of $18 a share that did not include property in Tokyo, Paris and London. He accumulated JWT’s stock with the average cost of just over $8/share. A year later, he sold his position at well over $20/share.
As he proceeded with this specialization into buying cheap securities, he reached two conclusions.
- Very few people really do their homework properly, so now I always check for myself.
- If you have confidence in your own work, you have to take the initiative without waiting around for someone else to take the first plunge.
Don't mistake him for a gambler. He was a risk-taker and his risks would be carefully calculated. He was willing to invest in a stock provided the “downside was measurable and acceptable and the chances of a good profit appear to be better than 50%.”
Take the case of Tiffany and Co. In the 1970s, the perception of the iconic luxury jeweler and silversmith turned negative. Cundill believed it was also extremely undervalued.
What made him arrive at that conclusion? The value of the company’s assets.
First, the famous Tiffany Diamond, a 128.5 carat brilliant canary-colored piece that, at the time, was the largest diamond in the world. Tiffany was carrying the diamond on the balance sheet at $1, despite an offer of $2 million.
Secondly, Tiffany owned Manhattan real estate and a factory in Newark. Both of these tangible assets were undervalued on the balance sheet.
Thirdly, the inventory was very conservatively valued.
Also, the company’s net income passed the $1 million mark for the first time ever in 1972 and reached $2.1 million the following year.
Tiffany’s shares were trading below book value of $10.5/share and in Cundill’s judgment well below the company’s realistic liquidation value. Cundill accumulated Tiffany’s share at an average of $8/share. Within a year, he sold his entire position at $19/share.
The one characteristic he believed all investors must have, but majority do not, is patience. He was convinced that sooner or later the market will do what it has to do to prove the majority wrong. But again, he is quick to admit that the wait could take years.
A case in point is his investment in Cleveland Cliffs, which he once said was his best investment. The company produced iron ore pellets and in the ’80s had 40% of the pellet market in North America. With a focus on growth stocks, the share price more than halved.
Cundill found that it had a power plant in Michigan, which was held at a very low value on the balance sheet. He got two friends to check it out and they reported that it was worth “a lot of money”.
In his own words, he said that he “bought and bought as the price went on dropping, and there seemed to be an endless supply of stock.”
Guru Focus noted that after Cundill’s initial purchase at $15/share, Cleveland Cliffs’ shares slid relentless to $6 per share. Cundill bought the shares on the way down at an average cost of $9.75/share. In two years, the shares hit $20. He sold his position at a great profit.
The icing on the cake was the crash of October ’87. Cleveland Cliffs’ shares plummeted again and Cundill bought back all the shares he had sold. The fund exited the position in 1991 with an annual compounded rate of over 30%.
Peter Cundill popularized the concept of “buying a dollar for 40 cents”. However, he did not blindly shop for cheap stocks. He did so after a thorough in-depth analysis of the balance sheet. He paid much more attention to the balance sheet than the profit-and-loss statement and always hunted for hidden assets on the books. He then combined a margin of safety approach with the right temperament. All in all, a winning strategy.
It seems fitting to end with his advice to investors, which he gave during a Globe and Mail interview.
Pick some first-rate money managers with whom you feel comfortable because you have done your homework on them. Then stick with them. The mantra is patience, patience and more patience. Think long-term and remember that the big rewards accrue with compound annual rates of return.
