In the first chapter of his book, A Zebra in Lion Country, famed investor, talented writer, and well-known Acorn Fund manager Ralph Wanger likens the experience of a portfolio manager to a zebra:
Zebras have the same problem as institutional portfolio managers like myself.
First, both have quite specific, often difficult-to-obtain goals. For portfolio managers, above-average performance; for zebras, fresh grass.
Second, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions.
Third, both move in herds. They look alike, think alike and stick close together. If you are a zebra and live in a herd, the key decision you have to make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while those in the middle see only grass that is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better.
On the other hand – or hoof – there comes a time when lions approach. The outside zebras end up as lion lunch. The skinny zebras in the middle of the pack may eat less well but they are alive.
A portfolio manager for an institution such as a bank trust department, insurance company or mutual fund cannot afford to be an Outside Zebra. For him, the optimal strategy is simple: stay in the centre of the herd at all times. As long as he continues to buy the popular stocks, he cannot be faulted. On the other hand, he cannot afford to try for large gains on unfamiliar stocks, which would leave him open to criticism if the idea failed.
Needless to say, this Inside Zebra philosophy doesn’t appeal to us as long-term investors. We have all tried to be Outside Zebras most of the time, and there are plenty of claw marks on us.1
THE VALUE INVESTOR AS AN OUTSIDE ZEBRA
We think Ralph Wanger’s analogy is an important message for value investors: True value investors buy only when a stock is too cheap and sell when the market price is too high compared to the company’s true intrinsic value. While value investing is a style of investing that a fair number of professionals talk about, in our opinion, there are very few who practice it successfully. Like being an Outside Zebra, being a value investor is often an uncomfortable position to be in. It requires the willingness to do what is unpopular and the discipline to stick with your decision while most investors are going in a different direction.
At Burgundy, we are entirely committed to value investing. Doing it successfully is, we believe, our greatest strength.
VALUE IN CANADIAN EQUITIES
There is a great start to 1993 as the Burgundy Canadian Equity Fund returned 19.9% compared to 8.3% for the TSE 300 Index. While one swallow does not make a summer, it is nice to score a few runs early in the ballgame. This extends the record of outperformance relative to the Index dating from 1981 by the Fund’s manager, John Di Tomasso.
We focus our attention towards purchasing and selling specific investments while staying true to our “bottom-up” value investing approach. This technique is especially pertinent to stock selection. We are the other end of the spectrum from the “top-down” approach, which is an attempt to understand and determine the implications of the big picture (global macroeconomic factors such as interest rates, currencies, etc.). This overview then works its way down through the Canadian economy and various industry groups and eventually assesses individual securities within those broader contexts.
The top-down method is comprehensive – too comprehensive, actually. There is simply more information (which changes by the minute, incidentally) than any person or group of persons can assimilate and properly integrate into a world view designed to produce successful investment decisions. Given the millions of factors that must be identified, understood, and correctly placed within a dynamic context, the job requires superhuman effort and ability.
At Burgundy, we recognize that weighty matters like GNP growth, future interest rates, and central banks’ monetary policy affect securities markets in a major way. And while it is fun to play armchair economist over a cognac or two, even then, it is difficult to get a consensus, let alone a confident conclusion. So, in our experience, the result of all of this work is economic forecasts that have little predictive value where it counts: investment results.
We have found that it is better to focus our efforts on the valuation of individual companies, particularly on the calculation of intrinsic value and the comparison of intrinsic value to market price.
However, after this disclaimer regarding macroeconomic analysis, our general view is that we are in a recovering economy, if only in a slow way. Canada has had three very grim years, and we feel that some factors are now improving. It should be remembered that Canada is basically a very rich country. Significant restructuring of companies, closing inefficient operations, increasing productivity and paying attention (at last!) to international competitiveness have all been going on in a major way for several years. While painful, these steps should lead to a stronger base and eventually a more prosperous corporate Canada.
Most importantly, some good companies are available at very reasonable prices compared to Burgundy’s estimate of the company’s intrinsic value. These bargain companies appear in various areas of the economy but, in our opinion, they are now particularly prevalent in the industrial (St. Lawrence Cement, Dofasco) and financial sectors (TD Bank, National Trust). The opportunities are less common now than a year ago; the stock market has gradually increased in price and is an average of 9% higher than it was then.
It goes without saying that a stock should be sold when it becomes fully priced. Sometimes, however, a particular stock (for any number of reasons) will become the darling of the street and gain momentum, or an industry will capture the imaginations (and the pens) of brokerage analysts. At such times, even though our targeted price might have been reached, we might hold onto the entire position or sell only a part of it to let the market carry the stock higher. This is not our usual practice, mind you, since it presumes that this overpriced security will become even more overpriced – the greater fool theory. True, market prices do fluctuate between extremes of overvaluation and undervaluation. Still, one must recognize that holding an overpriced stock implies, from that point, a greater price risk than the potential reward.
Although we are still able to find enough Canadian opportunities to efficiently diversify our portfolios, they are becoming fewer and we may set aside cash reserves as targeted sales take place.
VALUE IN THE U.S. IS HARDER TO FIND
We find it difficult to identify bargains in the United States as stocks overall are being valued at much higher levels than in Canada. Nevertheless, we have established positions in a few new American companies that we judge to be of outstanding value.
An example is Loews Corp. (NYSE $98, following its recent sharp decline). We believe that Loews is an excellent example of a good company that is significantly undervalued. The key reasons follow:
- Loews is run by a great investor and businessman, Larry Tisch. There is no doubt that Tisch is one of the great investors of our day and someone we have admired for many years. In John Train’s book The Money Masters, Train includes a full chapter on Mr. Tisch, who is ably assisted in his endeavours at Loews by several relatives, including his son Jim. Insiders own 26% of the stock.
- Over the past 10 years, book value per share has grown from $16.92 in 1982 to $84.10 in 1992, which, coupled with dividends, means shareholders have had a return of 20.7% per annum over the decade.
- Loews is in casualty insurance (control of CNA Insurance), tobacco (Lorillard), Loews Hotels, Bulova Watches and CBS Television. Through CNA, Loews has a very large securities portfolio and also a large corporate portfolio.
- The company has an excellent financial record with 10-year return on equity averaging over 15% and an even better record of building shareholders’ value since Loews had consistently been buying back its own stock for many years. This is clearly a company exhibiting canny capital allocation skills, using excess cash flow to buy back its own undervalued stock and creating value on a very tax-efficient basis for its shareholders.
- The loss in 1992 reflects the establishment of a $1.5 billion reserve at CNA for asbestos suits.
- The current share price is $98. If the book value is adjusted to market for its CNA shares (it is a public company on its own) and availing Lorillard at 10 times pre-tax earnings, Loews is worth $195 per share or twice the current price.
- The current price of $98 compares to recent analyst estimates of $11 per share for a PE ratio of 8.9 times.
1. A Zebra in Lion Country by Ralph Wanger. New York: First Touchstone Edition, Simon & Schuster, 1999.
This post was updated in March 2021.
This post is presented for illustrative and discussion purposes only. It is not intended to provide investment advice and does not consider unique objectives, constraints or financial needs. Under no circumstances does this post suggest that you should time the market in any way or make investment decisions based on the content. Select securities may be used as examples to illustrate Burgundy’s investment philosophy. Burgundy funds or portfolios may or may not hold such securities for the whole demonstrated period. Investors are advised that their investments are not guaranteed, their values change frequently and past performance may not be repeated. This post is not intended as an offer to invest in any investment strategy presented by Burgundy. The information contained in this post is the opinion of Burgundy Asset Management and/or its employees as of the date of the post and is subject to change without notice. Please refer to the Legal section of this website for additional information.
