Francis Chou, a well-regarded Canadian value investor, the founder of Chou Associates Management, and Morningstar Fund Manager of the Decade in 2004, was once just an ordinary immigrant in Canada with $200 in his pocket. Even though he is Chinese, he was born and raised in India, and came to Canada looking for a job. For a few years he worked as an electrician, and while he was soldering wires he stumbled upon an article about value investing, which immediately caught his eye. That moment he knew what he wanted to do. Looking for the bargains was and is his motto.
It all began back in 1981, when Chou convinced his colleagues to pool their money with him. His private investment club fund generated good returns over the course of five years – from 51,000 to $1,5 million and grew into a publicly available mutual fund named Chou Associates Fund. Chou likes to work alone and looks for the best values.
Since its inception in 1986 Chou Associates Fund had an average annual return of 10.4%, and only had 8 down years. Over the past 15 years, the fund gained 6.43% on average, during same period the S&P 500 index gained 6.8% annually. However, Chou’s returns over the last 10 years (and especially over the last 5 years) significantly trailed the market. Over the past 10 years, the fund had an average annual return of 6.44%, while the S&P 500 gained 10.6%. More dramatically over the 5 years Chou Associated generated an average annual return of 4.98% vs. S&P 500’s annual return of 13.5%.
We don’t think it is a good idea to be non-diversified. Value investing funds have been underperforming the market by large margins in recent years. Insider Monkey’s flagship strategy identifies the best performing 100 hedge funds at the end of each quarter and invests in their consensus stock picks. This way it is always invested in the best ideas of the best performing hedge funds and is able to generate much higher returns than the market. Since its inception in May 2014, our flagship strategy generated a cumulative return of 121% vs. a cumulative gain of 66.6% for the S&P 500 ETF (SPY) (see the details here). Chou’s investors would have been better off if they had followed our strategy instead of Chou’s stock picks.
When we take a look at Francis Chou’s latest moves we noticed that Chou invested in a lot of questionable companies that are shunned by the best performing hedge fund managers. Chou’s portfolio contained troubling pharmaceutical stocks that were once very popular, such as Valeant Pharmaceuticals International (VRX) which has changed its name to Bausch Health Companies Inc. (BHC), as well as Sears Holdings Corporation (SHLD) and Resolute Forest Products (RFP). In his semi annual report for 2018, Francis Chou explained that his investment in pharmaceutical stocks is guided by the idea of a ‘basket approach’, believing there is still some hidden value they carry. As for the Sears Holdings Corporation (SHLD), Francis Chou admits that this investment was led by too much of a good faith, while Resolute Forest Products’ (RFP) new CEO brings more optimism. Let’s take a look at what Francis Chou said:
“We believe that pharmaceutical stocks as a group are selling at attractive valuations. They generate their earnings in cash and at the time of purchase, they were selling at less than 10 times earnings. Some of them are down more than 50% from their highs, which is what caught our attention initially. As discussed earlier in past reports, we invested more than two pharmaceutical companies (that is, to utilize a so-called “basket approach”), in order to reduce the potential adverse effect on fund returns that could result from Food and Drug Administration (FDA) approval and patent expiration issues faced by a single company. We have invested in the following pharmaceutical stocks:
| Pharmaceutical Stocks | Price as of Dec. 31. 2017 | Price as of June 30. 2018 | Percentage Increase |
|---|---|---|---|
| Bausch Health Companies Inc. | $20.78 | $23.24 | 11.8% |
| Endo International | $7.75 | $9.43 | 21.7% |
| Sanofi | $43.00 | $40.01 | (7.0%) |
In conclusion, we believe pharmaceutical stocks as a group are selling at attractive valuations, in comparison to the free cash flow and earnings they generate.
Sears Holdings
In hindsight, our initial assessment of Sears Holdings being worth more than $50 per share a few years ago was most likely too optimistic. This is taking into consideration that we received in excess of $23 per share in distributions from various spin-offs and right offerings, which we later sold in the market.
In 2017, we initiated a stock lending program where the Fund received interest on the shares lent. For Sears Holdings, the total security lending interest we received for the year was about $7.25 million or about $6.41 per share, all in U.S. dollars. This shows how heavily shorted the common shares of Sears Holdings have been. For the six-month period ending on June 30, 2018, the total security lending interest received was $483,596 or about $0.43 per share, all in U.S. dollars. In spite of the interest income earned from security lending, plus the approximately $23 per share received in distributions from various spin-offs and rights offerings, it has not been a good investment.
Resolute Forest Products
As of June 30, 2018, the market price of Resolute Forest Products (RFP) was at $10.35 per share, giving a market capitalization of roughly US$935 million dollars. As we have explained in the past, the company continues to have consolidated sales of close to US$3.5 billion and in each of its major business segments, it is a global leader. It continues to be the biggest volume producer of wood products east of the Rockies, the third largest in North America for market pulp, the number one producer of newsprint in the world and the largest producer in North America of uncoated mechanical paper and an emerging tissue producer. The wood products segment continues to have revenues of approximately US$800 million, while the other three segments each continue to have revenues of approximately US$900 million. We believe that each of the four business segments could fetch at least US$400 million in a normal market and, as a result, RFP may be undervalued.
With the new CEO coming in, there is more optimism on what the company can do with its four business segments. This is reflected in the stock price as it has moved up from $4.60 in March 2017 to $10.35 as of June 30, 2018.”
Sears Holdings Corporation (SHLD), Bausch Health Companies Inc. (BHC), Resolute Forest Products (RFP), and Endo International Plc (ENDP) are all crowded by value investors who are hoping for a swift turnaround (for example Prem Watsa owns around one third of Resolute Forest Product’s outstanding shares). They all had between 16 and 23 hedge funds with bullish positions whereas popular stocks with similar market caps usually attract 35 to 45 hedge funds. On the other hand Sanofi Aventis (SNY) seems like an odd choice as hedge funds collectively own less than 1% of this stock’s outstanding shares. So, this stock is under the radar of almost all types of investors. Sanofi Aventis (SNY) was recently in the news because of the charges that its subsidiaries in the Middle East and in Kazakhstan have made a corrupt payment to win over business. The company neither denying neither admitting the accusations, granted to pay $25 million to resolve the charges.
Overall, we don’t think Chou’s current stock picks will generate market beating returns in the near future.
