“There's Always Something to Do: The Peter Cundill Investment Approach”
This was a re-reading, as I first read it more than 10 years ago when it was published.
There are a lot of books that shaped my investment philosophy, and even more than The Intelligent Investor (which is a good starting point for neophytes but it's too basic for experienced practitioners), for me this book encompasses the real value of value investing. It is also much more international than similar books, which are typically US-centred: Peter Cundill was an inveterate traveller who would routinely clock up well over a hundred thousand miles a year in the quest for bargains in international markets and especially for his habit of making a special effort to visit whichever country had had the worst performing stock market in the previous eleven months.
One of my “highly recommended” readings with Capital Returns and Seth Klarman’s Margin of Safety.
Note: I’m fully aware that value investing as defined by academics and advisors has not worked for 15+ years, because some metrics (in particular P/BV) are way less relevant today for a lot of good reasons. And that Graham’s net-nets are almost impossible to find nowadays. But value investing is not buying low growth, beaten down companies trading at bargain multiples: it’s the discipline of the investment and valuation process that (still) matters.
A “road to Damascus” moment
The book is a biography that draws heavily on journals’ entries kept by Peter Cundill from 1963 to 2007, with topics ranging from his personal life to business and investing: he passed away in 2011 at the age of 72 from FragileX syndrome, an untreatable neurological disorder.
While already a successful money manager, in late 1973 Peter happened to read Supermoney by George Goodman (written under the pseudonym Adam Smith: by the same author, The Money Game) whose chapter 3 is devoted to Warren Buffett and Benjamin Graham. The concept of “margin of safety” struck Peter as a thunderbolt: there, in plain terms, was the method and the solid theoretical back-up to selecting investments based on the principle of realizable underlying value.
Peter refers to this as his moment of “epiphany”: 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.”
Cundill Value Fund was launched in 1975 and compounded at 15.2% over the next 33 years.
Investing ≠ forecasting what will happen to markets
In his search of a unifying investment theory, he arrived at two important conclusions: that the majority of models used by investment research departments were essentially worthless and that attempting to make general market calls was a “mug’s game.” Management’s ability to predict earnings is also universally poor.
“I think that intelligent forecasting (company revenues, earnings, etc.) should not seek to predict what will in fact happen in the future. Its purpose ought to be to illuminate the road, to point out obstacles and potential pitfalls and so assist management to tailor events and to bend them in a desired direction. Forecasting should be used as a device to put both problems and opportunities into perspective. It is a management tool, but it can never be a substitute for strategy, nor should it ever be used as the primary basis for portfolio investment decisions.”
Most of the analytical tools tend to be heavily reliant on extrapolating history and market calls involve far too many variables, as well as being conditioned by the herd instinct, which, more often than not, is triggered by some completely unpredictable event.
He also concluded that pure chartists were simple fantasists, in approximately the same category as those gambling punters who believe that they can predict the next fall of a roulette ball on the basis of previous history.
In addition to general rules (“In a macro sense it may be more useful to spend time analysing industries instead of national or international economies”), this helped him define the specific rules for his stock picking:
“In essence, the fund invested in companies that, as a result of detailed fundamental analysis, were trading below their “intrinsic value.” The intrinsic value was defined as the price that a private investor would be prepared to pay for the security if it were not listed on a public stock exchange. The analysis was based as much on the balance sheet as it was on the statement of profit and loss. Based on my studies and experience, investments for the Venture Fund should only be made if most of the following criteria are met:
The share price must be less than book value. Preferably it will be less than net working capital less long-term debt.
The price must be less than one half of the former high and preferably at or near its all-time low.
The price earning multiple must be less than ten or the inverse of the long-term corporate bond rate, whichever is the less.
The company must be profitable. Preferably it will have increased its earnings for the past five years and there will have been no deficits over that period.
The company must be paying dividends. Preferably the dividend will have been increasing and have been paid for some time.
Long term debt and bank debt (including off-balance sheet financing) must be judiciously employed. There must be room to expand the debt position if required.
Distressed debt
As a value investor, during the 1980s he also dabbled into distressed debt, initially with the help of Michael Milken and Drexel Burnham Lambert in corporates, and later in South American sovereign debt with Deltec.
Distressed debt fitted perfectly into his Graham and Dodd framework because the departure point in researching distressed corporate debt is always the balance sheet. What one needs to determine is whether, as the reorganization, or the liquidation, proceeds in an orderly fashion rather than a panic sale, the sum of the parts, or the rump of the business, is worth more than the debt at its discounted price. Will the company be in a position to pay a sufficient redemption price in a negotiated settlement with the bondholders to make the investment worthwhile?
The October 1987 crash
It’s not a surprise that a real value investor was more than well prepared by the time the crash finally arrived, with over 40% of the fund’s assets in short term money market instruments.
However, he always stressed that this positioning was not the result of a deliberate decision to build up cash because, although he had anticipated a crash, he could not have predicted its exact timing. The enlarged cash position was actually the result of the increasing number of securities in the portfolio that had been attaining prices considerably in excess of book value, consequently qualifying them for an automatic sale unless there were overriding reasons to hold on to them. It was in effect the perfect example of the way the value discipline in action provided a form of inbuilt safety valve.
“As I see it, with money being recklessly printed, higher inflation and higher interest rates must be just around the corner and so must the likelihood of a real and possibly violent stock market collapse. I have an unpleasant feeling that a tidal wave is preparing to overwhelm the financial system, so in the midst of the euphoria around I’m just planning for survival.”
“They have shut the exchange for three days until Monday – a wise move on balance. As I have watched events unfold I have come to the conclusion that computers actually don’t do much more than make it quicker for investors to react to information. The problem is that having the information in its raw state on a second by second basis is not at all the same thing as interpreting and understanding its implications, and this applies in rising markets as well as falling ones. Spur of the moment reactions to partially digested information are, more often than not, disastrous. My impressions of the last week are that most people in shock need to share their gloom and doom, to reassure themselves that they are not out there on their own, and so it feeds on itself.”
By the end of 1989, the Cundill Value Fund had recorded a streak of 15 years of positive returns, for a 22% annualised return.
On stubborness
“It was a big position in the Value Fund and, while it was not in the end a loss in absolute terms, on the basis of the “time value” of money, the emotional wear and tear that it caused, and the man-hours wasted, it was a dismal result and had dragged down performance. The lesson, however, was thoroughly absorbed and Peter acknowledged that patience and stubbornness are not necessarily the same things, although an element of stubbornness has to be an essential attribute of all successful value investors. What provides the vital balance is a willingness to reanalyse and reappraise all assumptions and calculations throughout the process.”
On investment committees
“To my knowledge there are no good records that have been built by institutions run by committee. In almost all cases the great records are the product of individuals, perhaps working together, but always within a clearly defined framework. Their names are on the door and they are quite visible to the investing public. In reality outstanding records are made by dictators, hopefully benevolent, but nonetheless dictators. And another thing, most top managers really do exchange ideas without fear or ego. They always will. I don’t think I’ve ever walked into an excellent investor’s office who hasn’t openly said “Yeah sure, here’s what I’m doing.” or, “What did you do about that one? I blew it.” We all know we aren’t always going to get it right and it’s an invaluable thing to be able to talk to others who understand.”
Timing: when to buy and when to sell
“As I proceed with this specialization into buying cheap securities I have reached two conclusions. Firstly, very few people really do their homework properly, so now I always check for myself. Secondly, 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. I haven’t yet found a solution for determining timing on the sell tack. People say it ought to be largely dependent on one’s perception of the trend in the overall stock market, but I am suspicious of this. I think that the financial community devotes far too much time and mental resource to its constant efforts to predict the economic future and consequent stock market behaviour using a disparate, and almost certainly incomplete, set of statistical variables. It makes me wonder what might be accomplished if all this time, energy, and money were to be applied to endeavours with a better chance of proving reliable and practically useful.”
A common affliction for many value investors is to sell too early: value investing is about exploiting perceived mispricing in securities, but selling too early risks abandoning long term growth stories.1 Peter’s solution (a compromise, in his own words, but very effective) was to automatically sell half a position when it doubled, in effect thereby writing down the cost of the remainder to zero with the fund manager then left with the full discretion as to when to sell the balance. The other common problem for value investors is often to also buy too early, and that happened exactly to Cundill in Japan in 1994.
The best strategy is often: "Sit on Your Ass Investing" (cit. Charlie Munger)
“This is a recurring problem for most value investors – that tendency to buy and to sell too early. The virtues of patience are severely tested and you get to thinking it’s never going to work and then finally your ship comes home and you’re so relieved that you sell before it’s time. What we ought to do is go off to Bali or some such place and sit in the sun to avoid the temptation to sell too early.”
Investors, however, are much less disciplined and always think that they are smarter than the market and the portfolio managers to whom they delegate their money: Cundill Value Fund was an open-ended mutual fund and experienced investor outflows in 1987 despite the good results. This is a common frustration of many fund managers. Even if the performance of the fund itself is good, many investors buy and sell at the wrong times.
Three common traits that the best analysts share
Insatiable curiosity
“Curiosity is the engine of civilization. If I were to elaborate it would be to say read, read, read, and don’t forget to talk to people, really talk, listening with attention and having conversations, on whatever topic, that are an exchange of thoughts. Keep the reading broad, beyond just the professional. This helps to develop one’s sense of perspective in all matters.”
Attention to details
“Never make the mistake of not reading the small print, no matter how rushed you are. Always read the notes to a set of accounts very carefully – they are your barometer. You need sound simple arithmetic skills, not differential calculus. They will give you the ability to spot patterns without a calculator or a spread sheet. Seeing the patterns will develop your investment insights, your instincts – your sense of smell. Eventually it will give you the agility to stay ahead of the game, making quick, reasoned decisions, especially in a crisis.”
Scepticism
“Scepticism is good, but be a sceptic, not an iconoclast. Have rigour and flexibility, which might be considered an oxymoron but is exactly what I meant when I quoted Peter Robertson’s dictum ‘always change a winning game.’ An investment framework ought to include a liberal dose of scepticism both in terms of markets and of company accounts. Taking this a step further, a lot of MBA programs, particularly these days, teach you about market efficiency and accounting rules, but this is not a perfect world and there will always be anomalies and there is always “wriggle room” within company accounts so you have to stick to your guns and forget the hype.”
Intelligence is only part of the equation:
“Just as many smart people fail in the investment business as stupid ones. Intellectually active people are particularly attracted to elegant concepts, which can have the effect of distracting them from the simpler, more fundamental, truths.”
“There’s almost too much information now. It boggles most shareholders and a lot of analysts. All I really need is a company’s published reports and records; that plus a sharp pencil, a pocket calculator, and patience.”
On discounted cash flows
“Discounted cash flow (dcf) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through dcf analysis is higher than the current cost of the investment, the consensus is usually that the investment opportunity is a good one.
“When it comes to using discounted cash flows I have a firm view. I was reading some work and it uses discounted cash flows and some sophisticated stuff and I am not good enough at math to be able to work out that kind of stuff and I have sort of come back in my simple way to Graham who said if you can’t add it, subtract it, multiply or divide it, then the math is too heavy. And the problem with this kind of cash flow is that it is simply a projection and, whatever the rate you choose to use, that will almost certainly shift on you. So you are trying to make two imprecise variables into a precise tool and that could get you into a whole mess of trouble.”
Best quote of the book
Buying cheap things (per sè) is not a guarantee for good returns:
“I bought stuff at 3.5 cents once and I thought it can’t go down to zero. It can.”
This is something that I will never get tired of repeating: value investing is NOT buying cheap assets on formulaic valuations (P/E, P/BV, dividend yield, …): it’s much more than that, and involves a full business analysis rather than just a mere valuation.
Although Peter Cundill is not nearly as well-known as many other famous investors, this is an excellent book for any serious investor. One of the main takeaway is that it is critical to write down your investment ideas (in a journal, a blog or Substack!) so you can refer back to your original thesis over time.
Christopher Risso-Gill: There's Always Something to Do: The Peter Cundill Investment Approach
Benjamin Graham’s best investment, by far, was in a growth company, GEICO, a 500 bagger.