Value investing is the discipline of purchasing a security at a significant discount to its current underlying value, and then holding it until more of the value is recognized. The key to value investing is indeed discipline in the truest sense of the word: one must have patience and resolve since, more often than not, one can appear to be wrong, at least in the short run. An asset can rarely be cheap and popular at the same time. It can take a long time for value to surface.
While all investing carries risk, buying an asset at a discount means that the investor has limited the downside risk from the purchase price—essentially building in a margin of safety. This margin is effectively an option on the recovery of that business or restoration of that stock to investor favour. If an undervalued stock drops after purchase, the disciplined value investor buys more, having confidence in the analysis that led to the purchase in the first place.
It is not easy to be a value investor, but, in our opinion, it is the only investing strategy that works over the long run. This year, there have been takeover offers on two of our portfolio holdings. In one instance it took over five years for value to be recognized by the market. The other only took six weeks.
On March 16 of this year, Bell Canada announced that it had reached an agreement to buy Astral Media for $50 a share. The offers represented a 38% premium to Astral’s share price on March 15th. We began acquiring shares in Astral Media for some of our clients in early 2007, when it was trading in the low $40 range. Astral Media had all the characteristics of a value investment: A low valuation to earnings, rising dividend payments, a strong balance sheet and a sustainable business model
When the recession hit, like most companies, Astral’s stock price plummeted, falling in 2008 to under $20 a share. However, Astral’s revenues, profits and dividends actually grew during the recession. By 2010 even though its earnings were now 20% above its pre-recession levels, Astral’s stock remained in the doldrums. If a stock was a good buy at $40 and its business is improving, then it is a great buy at $20. So we acquired even more shares for new and existing clients. As we waited for Astral’s value to surface, our clients collected a nice dividend each year, a dividend which doubled between 2007 and 2011. Finally, two months ago, Astral’s takeover deal was announced. The takeover premium recognized the value which we had seen in the company, validated our original analysis, and confirmed the wisdom of holding and adding to our position.
Last summer, we acquired a stake for some of our clients in an apartment rental company called Canadian Apartment REIT, or CAP REIT for short. In an environment of rising real estate prices, low interest rates and an accommodative immigration policy, we reasoned that apartment building ownership would be a good business. We started acquiring CAP REIT around $17 a share, and we continued to buy this stock for clients over the next few months. In early March 2012, CAP REIT’s stock was trading at over $22 a share, an increase of about 30% in less than a year. We noticed that CAP REIT was now trading at a 20% premium to its closest competitor, Transglobe Apartment REIT.
Value investors always compare companies in the same industry to get a relative sense of value. After analyzing Transglobe, we struggled to understand why it was trading at such a significant discount to CAP REIT. Both CAP REIT and Transglobe had about 30,000 apartment suites, mainly in Southern Ontario. For some reason, CAP REIT was valued by the market at a premium to Transglobe, yet Transglobe offered its investors a much higher dividend yield.
Our analysis led us to sell all our CAP REIT and switch it for Transglobe. We reasoned that if Transglobe traded at a similar valuation to CAP REIT, it should be worth about $14 a share, while we could buy it at about $12. Six weeks later, that’s exactly what happened; a consortium of investors, including CAP REIT, announced it was buying Transglobe for $14.25 a share. This takeover of a portfolio investment at a premium to what we paid was a satisfying confirmation that value investing works. We are confident that our clients will continue to reap the benefits of our investing approach.
When one hears the term “value investing”, the name Warren Buffett comes to mind. Buffett, however, will give all the credit to his mentor the late Benjamin Graham, widely credited as the founder of the value investment school of investing. Graham said:
“You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right – and that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.”
Disclosure: Author owns shares in BCE. Clients of Baskin Financial owns share in BCE, Canadian Apartment REIT and Transglobe Apartment REIT