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Friday, July 06, 2007

the search for value

Not too long ago I was perusing some back issues of Outstanding Investor, a quirky publication featuring interviews with top investment managers. In spite of the editors ongoing love affair with Warren Buffet, I enjoy this publication and think it is one of the very best sources of investment ideas. While reading, I found an old interview with Peter Cundill, a value fund manager of some note who hails form Canada ad has much success applying his approach around the globe. In the interview, Cundill mentioned that one of us favorite screening methods was to search for stocks that trade below tangible book value, are profitable and pay a dividend. His reasoning was that if the assets were sound, then one was purchasing the earning power and dividend of the company basically for free and that this would provide a large margin of safety with upside potential. Sounds reasonable, doesn’t it?

I decided to run the criteria through a back test using the programs at, an excellent site for quick and dirty checks on ideas and systems. The only drawback is that you are limited to the value line universe of stocks, but for quick tests it is excellent and easy to use(any suggestions for other backtesting tools welcome). I ran the test from 1986 through the end of 2006 and found that, indeed the results are excellent. The criteria returned an average of 17% versus the SP500’s 12 and had only 2 down years in the last 20. In fact, it has not been down January to December since 1990! Take note, however that 1990 was a doozy of a down year, down almost 30%.

I like this approach to screening. The presence od the dividend means that in all likelihood the company is generating more than enough cash to meet its bills and has enough left over to return to the shareholders each year. The profits make it less likely for the company to burn up assets and cash just too keep itself afloat. As always keep in mind that screening is the start of the process not the end and a more investigation must be done. As Chris Browne once remarked, first underwrite and then investigate.

What kind of stocks can we uncover today using this approach? Not too many household names that for sure. The stocks found here are going to be unloved and undiscovered and not mention of the tv shows until they are taken over or discovered by an eagle eyed analyst. When I ran the screen I included an extra margin of saety characteristics by adding a current ration of more than one. I have found over the years the more ways I prevent myself from being exposed to dangerous dying situations the more likely I am to avoid value traps and value destroyers. The current ratio just assures enough cash and short term assets exist to pay the bills without borrowing or looting the company.

There were as expected a lot of small banks and insurance companies on the list including such gems as Beverly Hills Bancorp (BHBC) which recently hired an advisor to look into selling the bank, Broadway Financial(BYFC) a small bank with a mostly Hispanic clientele in Los Angeles that has had recent insider buying trading at 85% of book value; Eastern Insurance holdings (EIHI) , a small workers comp and group insurance firm that has started getting analyst coverage with Keefe Bruyette rating it a buy with positive comments; Presidential Life a life insurance and annuity concern that has had recent insider buying. There are more but I think that gives some idea of what type of stocks this screen will turn up right now. With the market having had an extended run, its is going to be small and microcap names that turn up.

Among the no financial names were companies like Citadel Radio ( cdl) the company that just purchased ABC radio for Disney and now has over 100 radio stations across the nation; The challenging furniture market has seen the shares of Furniture brands and Haverty Furniture fall low enough to meet the criteria with both of these catching the yes of notable investment firms and activists in recent months; McClatchy News(MNI), the newspaper concern with over 30 daily papers around the country (these shares have been purchased by both Citadel and Renaissance taking good size positions of late. One of my favorite stock LS Starret(SCX) a company in the always exciting handheld tools business shows up as well. Again as with the banks and insurance companies not household names but viable business’ that pay dividends and sell cheaply compared to tangible book value.

In the continuing search for stock ideas the Cundill screens appear to be another viable method for searching out this, tails I breakeven, heads I win big stocks that I have found to work best for me over the years. The returns have always been very “frog” with value sitiing still until something unlocks then and leads to good size gains but it has so far been profitable. Lets hope it stays that way.

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