Last night I was going through some of Francis Chou’s annual letters to his Associates Fund holders. Chou manages investment funds for Chou Associates Management Inc., and his Associates Fund has compounded annual returns of 15.4% over the last fifteen years, compared to 10.5% for the S&P 500.
In his 2001 annual report, Chou highlights the criteria that he has used to find his best bargains:
“Over time I have sifted through thousands of bargains which have come in different shapes and flavours such as discount to net-net working capital, discount to book value and low P/E ratio. When all is said and done, those which continue to give me the greatest satisfaction are the ones which display the following characteristics:
1) Above-average to excellent companies as measured by high ROE in excess of 15% sustained over 10 years or more.
2) Companies run by skillful managers as measured by good controls maintained on receivables, inventory and fixed assets.
3) Prudent deployment of capital as measured by a company’s capital expenditures, judicious acquisitions, and timely buybacks of its depressed shares.
4) A stock price which is far lower than what a knowledgeable and rational buyer would pay.
BMTC Group met the above criteria in spades. And when companies such as this one are found, the only rational thing to do is buy as much of the stock as the legal limit allows. In these instances it’s not always necessary to be extra careful about the buy price as long as this price falls within a single digit P/E ratio. Even on the sell side, there isn’t a pressing need to time the sale as the stock price nears its intrinsic value – the reason being that the company’s intrinsic value is growing in excess of 15%.”
Chou’s specificity here and his example of BMTC Group are very useful for the aspiring investor. Most simply, Chou needs to see sustained profitability, skillful management, prudent capital allocation, and a fair price. And when he finds it, Chou buys with conviction.