ABC Funds' 10 commandments of value investing

October 18, 2001

Low Price-to-Earnings (P/E) Multiples: Search out stocks trading at less than 10 times price-to-earnings multiples, which reduces the risk of overpaying for a security.

Low Price-to-Cash-Flow Multiples: Look for companies trading at less than five times a price-to-cash-flow multiple. This also reduces the risk of overpaying and uncovers many dirt-cheap equities.

Discount to Book/Net Asset Value: Buy stocks trading at a discount to book/net asset value. In many cases, this not only uncovers significantly undervalued stocks but also prime takeover candidates.

Hidden Assets: Some examples of hidden assets that can be uncovered after a thorough analysis are tax-loss carry forwards, over-funded pension funds, real estate, potential spin-offs, IPOs and favourable litigation.

Management: Two types of management could be key in the search for a turnaround candidate: a) solid, proactive management and b) poor management, which leaves the company ripe for a proactive acquisition or merger.

Products/Services in Tune with 2001 and Beyond: This includes expandable, growing markets with good margins. We tend to avoid companies with outdated, shrinking products.

Value Catalyst: To push up the value of a stock, we look for a significant value creator. Some examples of possible value creators are fresh management with new directions, an important sale or purchase of a meaningful asset, an unsolicited takeover bid or disgruntled and impatient proactive shareholders who may put pressure on management to make changes or sell.

Discounted Valuations Compared with its Peers: Comparative valuation measures such as price to earnings and cash flow could indicate a takeover by relatively expensive Canadian or foreign competitors looking to expand market presence.

Contrary Opinion and Under-followed by Investment Analysts: With little investor exposure, undervalued stocks are pregnant with possibilities, providing very little buying competition when we attempt to accumulate the security. Generally, an undervalued and under-followed security will offer terrific capital-gains opportunities.

Discipline: Stay on track and adhere to strict value discipline of low P/Es and strong cash flows and price targets. Do not get sucked into buying the flavour of the day! Combine patience and persistence to attain superior performance. Patience! Patience! Patience!

Source: Irwin Michael, ABC Funds (www.abcfunds.com)