“Find bargains and maintain discipline; if you can’t find bargains stay in cash.”
The stated goal of the Associate fund is to “provide long-term growth of capital by investing primarily in equity securities of US and foreign businesses considered by the manager to be undervalued.” As can be expected from his humble beginnings, Francis Chou at heart is a value investor. Chou looks for a large deviation from the current price of a security with respect to its intrinsic price. When this large margin of safety can be obtained, a thorough analysis of a company’s balance sheet, cash flow, profitability, future growth potential and leadership is utilized.
Nonetheless, any short term turbulence is disregarded in favor of positive aforementioned characteristics. To quote Chou in his 2010 letter, any fluctuations are classified as “a temporary quotation loss of capital and not a permanent loss of capital." In addition, when Chou deems pertinent, the firm also invests in bonds, convertible debentures, preferred shares, and other short term debt.
In addition to the firm’s primary fund, other investment options include the Asia, Europe, RRSP, and the bond fund. Each fund specializes in investments located in their namesake’s location or specialty, with RRSP investments primarily based in Canadian securities. The principal and core goals of these investments parallel that of the Associate fund, with a similar long term focus on margin of safety, and excellent fundamentals.
In terms of performance, Chou has a successful track record that earned him 2005 Fund Manager of the Decade designation from the Canadian Investment Awards program. In 2010 and 2009, he returned 19.21% and 29.7% respectively. This yielded an excess gain of 4.1% and 3.2% over the S&P benchmark return. In terms of cumulative returns, over a 10-year period, the fund returned 136.3%, vs. the benchmark return of 16.4% for the same period. In terms of its aggregate performance, the Chou Associate fund boasts of an 11.5% annualized return since its inception in 1986.
As can be seen in the following tables and charts, the greatest concentration of the portfolio lies in health care and consumer services at 34.70% and 19% respectively. However, health care saw the largest reduction from Q4 by a decline of 10.50%, while consumer services saw the largest gain at 4.40%. All of the other sectors saw minor changes, with no sector changing by a value exceeding 2.50%.
“The economics of a business are important. Ultimately, a company has to repay or restructure its debt.”
As demonstrated in the table, Chou Associates currently manages $407 million in 29 different equities and investments. The top five equity holdings of the portfolio comprise 46.77% of the entire fund. The overall portfolio is diversified, as the firm holds warrants from both Bank of America and Wells Fargo respectively, and long term notes from Level 3 Communications and Mankind Corporations.
AbitibiBowater produces newsprint, market pulp and wood products through 23 pulp and paper manufacturing facilities located internationally. Their shares currently trade at $22.80, with a market capitalization of $2.21 billion. An average price of $27.18 was paid per share of ABH, yielding a potential capital loss of 16.11%. ABH is the largest holding of Chou Associates, comprising 15.71% of the composite portfolio.
ABH currently has a P/E ratio of 15.35 and a P/S ratio of .46. For the fiscal period ending in 12/10, upon revenues of $4.7 billion, a net margin of 58.47% was yielded. Earnings for this period were $1.45 per share.
AbitibiBowater was named the Turnaround of the Year 2010 by the Turnaround Management Association. In other news, ABH sold 75% of its stake in Ontario Hydro Assets for approximately $300 million in Canadian dollars.
GuruFocus rated ABH with the business predictability rank of 1 star.
Watson Pharmaceuticals (WPI)
Watson Pharmaceuticals (WPI) develops, manufacturers and distributes both generic and brand name pharmaceutical products through three operating segments: Global Generics, Global Brands, and Distribution. Their shares trade at $64.93 with a market capitalization of $8.21 billion. WPI was acquired at an average price of $29.18, yielding a large capital gain of 122%. WPI is the second largest equity holding of the portfolio, comprising 8.74% of the overall fund.
WPI has a P/E ratio of 50.14, a P/S ratio of 2.24, and a P/B ratio of 2.42. For their most recent fiscal year, Watson Pharmaceuticals reported earnings of $1.28 per share. During the same period, a net income of $183 million was earned on revenues of $3.5 billion, yielding a margin of 5.14%. Over a 10-year period, WPI has historically grown its revenues and free cash flow by 11.9% and 14.2% respectively.
Watson Pharmaceuticals recently received FDA approval for their Lybrel drug, an oral contraceptive. Novartis AG is suing Watson Pharmaceuticals to block Watson’s sales of a generic form of one of their drugs, due to an alleged patent infringement.
GuruFocus rated WPI with the business predictability rank of 3 stars.
Overstock.com (OSTK) offers discounted brand name products, close-out merchandise, books, magazines, and video games. Overstock currently trades at $14.39 with a market capitalization of $335.03 million. Each share of OSTK was acquired at an estimated price of $27.09, yielding a capital loss of approximately 46%. Overstock Inc. is the third largest holding of the portfolio at 8.57% of the aggregate fund.
OSTK has a P/E ratio of 35.81, a P/B ratio of 10.15, and a P/S ratio of .29. For their most recent fiscal year, earnings of 41 cents per share were reported. Revenues were $1.08 billion for the year, with a net margin of 1.27%. Historically, over the last 10 years, OSTK has grown its revenues by 20.9% annually.
The Overstock Company recently announced the naming of the O.co Coliseum in Oakland that will coincide with its own name change, from Overstock.com to O.co. In addition, similar to other online retailers, the company is currently in dispute with the government over taxes paid in electronic transactions.
Sprint Nextel (S)
Sprint Nextel (S) offers wireless and wired communication products and services to both small and large scaled clients. Sprint currently trades at $5.33 with a market capitalization of $15.95 billion. An average price of $3.58 was paid per share of Sprint, yielding a capital gain of 48.8%.
Sprint has a P/S ratio of .48, and a P/B ratio of 1.07. Their most recent fiscal year reported losses of $1.02 per share. Their revenues for the year were reported at $32 billion, with a loss of $3.4 billion. On an annual basis, over the last 5 years, Sprint has grown its free cash flow by 4.5% historically.
Sprint recently announced the launching of more then 10 Motorola devices in 2011, due to a renewed business deal with Motorola. JP Morgan (JPM) announced they are maintaining their price target of $7 along with its “Overweight” rating on Sprint.
GuruFocus rated S with the business predictability rank of 1 star.
Sears Holding Corporation (SHLD)
The Sears Holding Corporation (SHLD) operates under their flagship brands of Kmart and Sears, with over 3,400 stores in operation. Sears currently trades at $71.50, with a market capitalization of $7.70 billion. Sears was acquired at an average price of $97.77, yielding a capital loss of approximately 27%.
Sears has a P/B ratio of .87, and a P/S ratio of .17. For their fiscal year ending in 1/11, revenues of $43 billion were reported, with a net income of $150 million, yielding a thin margin of .35%. Historically, SHLD has grown its revenues and book value by 7.9% and 13.5% respectively.
Sears upper management saw a change in command, as CFO Michael Collins recently resigned from the company to pursue other opportunities. In other developments, Sears reaffirmed efforts to revitalize their apparel division, and to maintain a leadership position in the market on appliances.
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