TAKING STOCK - November 16, 2009

Dumpster divers crowd value field

BRIAN MILNER

Twice in his long and prosperous career investing other people's money, Irwin Michael says his wife has suggested it might be time for him to hang up his cleats.

The first time occurred about a decade ago during the telecom bubble when the Bay Street value fund manager adamantly refused to buy then high-flying Nortel.

Lest we forget, this one-time Canadian star was trading at multiples that were beyond ridiculous and dominating the benchmark Canadian index. It cost him a lot of clients, who had obviously never studied Nortel's balance sheet.

They said his style was out of touch with the new economic realities. But he refused to jump on the momentum bandwagon or head down the path to what some of his colleagues in the business were calling “new value,” in an effort to keep the paying customers happy.

This past year, his wife broached the subject again when she saw the agony etched on his face. That tends to happen when nothing is working and market conditions are like nothing ever witnessed before, even by a veteran of the great bear markets of the mid-1970s and 1980s.

“The bottom line is we've gone through an extraordinarily difficult period,” Mr. Michael says. He points to a shelf full of financial books in his conference room. “There is nothing in those textbooks that explained what we were going through. … You question yourself. But the market was vicious.”

It was, he says, O'Toole's law at work. That's the dictum that holds Murphy was an optimist when he came up with the rule that anything that can go wrong will (eventually) go wrong.

“It's going to take a little longer to come out of. But at the same time, when you've got that massive negativity out there, there have been ways to make money.”

Mr. Michael, whose ABC Fundamental-Value Fund slid 44 per cent last year, stuck it out and continued trolling for undervalued stocks, mostly of the small to mid-sized kind.

Once markets started their surprising climb off the floor last March, things began looking up. Even the return of momentum traders and speculators to the market has been good for value players, he insists, because they have injected desperately needed cash.

“The biggest problem, particularly in the small to mid-cap [range] is that if you buy something cheap with not a lot of liquidity, you need the patience of Job to hang in until such time as the market recognizes [its value]. Sometimes, the market doesn't. And sometimes, it's a value trap. You buy something cheap and then you have to sell cheaper.”

Mr. Michael's fundamental value fund is up 40 per cent so far this year, joining a parade of much improved results in the value community.

But in his favourite playground, small-cap stocks have been on a tear, far surpassing the performance of their large-cap cousins and prompting market watchers to label this a monumental “junk” stock rally. Pint-sized U.S. equities have shot up nearly 70 per cent since the March lows to their highest level in 13 years.

And it's being led by still-wary investors who have little faith in the market's long-term prospects. A long-time Wall Street observer exclaimed last week that he's never seen so many fully invested bears.

One U.S. fund manager recently called it “dumpster-diving” by people who have scant interest in the stock fundamentals so fervently embraced by Mr. Michael and other value types. Who cares about, say, the quality of earnings when there's a hot trend to chase.

Doesn't that make it tougher for long-term value investors to find the underpriced bargains that are their stock in trade?

“It's not easy,” Mr. Michael acknowledges. “It was probably easier in March, when you could look at 10 stocks and buy five or six. Now, you're looking at 10 and maybe buying one or two. They're no longer dirt cheap.”

But he'll take this pricier, more liquid and volatile market any day over what he faced in the dark days of last fall and winter.

“If you're a disciplined value investor and someone has taken up your stocks far too much because there's insanity out there, you'll be supplying the stock to the marketplace.”

And for a buyer, those shorting speculators can make for a good source of supply.

“We're looking at fundamentals – book value, breakup [value], management. People who are working with squiggles on a chart or some computer program take a completely different tack. If they're taking the other side of the coin, that's fine with us.”


TAKING STOCK - November 16, 2009 Dumpster divers crowd value field BRIAN MILNER Twice in his long and prosperous career investing other people's money, Irwin Michael says his wife has suggested it might be time for him to hang up his cleats. The first time occurred about a decade ago during the telecom bubble when the Bay Street value fund manager adamantly refused to buy then high-flying Nortel. Lest we forget, this one-time Canadian star was trading at multiples that were beyond ridiculous and dominating the benchmark Canadian index. It cost him a lot of clients, who had obviously never studied Nortel's balance sheet. They said his style was out of touch with the new economic realities. But he refused to jump on the momentum bandwagon or head down the path to what some of his colleagues in the business were calling “new value,” in an effort to keep the paying customers happy. This past year, his wife broached the subject again when she saw the agony etched on his face. That tends to happen when nothing is working and market conditions are like nothing ever witnessed before, even by a veteran of the great bear markets of the mid-1970s and 1980s. “The bottom line is we've gone through an extraordinarily difficult period,” Mr. Michael says. He points to a shelf full of financial books in his conference room. “There is nothing in those textbooks that explained what we were going through. … You question yourself. But the market was vicious.” It was, he says, O'Toole's law at work. That's the dictum that holds Murphy was an optimist when he came up with the rule that anything that can go wrong will (eventually) go wrong. “It's going to take a little longer to come out of. But at the same time, when you've got that massive negativity out there, there have been ways to make money.” Mr. Michael, whose ABC Fundamental-Value Fund slid 44 per cent last year, stuck it out and continued trolling for undervalued stocks, mostly of the small to mid-sized kind. Once markets started their surprising climb off the floor last March, things began looking up. Even the return of momentum traders and speculators to the market has been good for value players, he insists, because they have injected desperately needed cash. “The biggest problem, particularly in the small to mid-cap [range] is that if you buy something cheap with not a lot of liquidity, you need the patience of Job to hang in until such time as the market recognizes [its value]. Sometimes, the market doesn't. And sometimes, it's a value trap. You buy something cheap and then you have to sell cheaper.” Mr. Michael's fundamental value fund is up 40 per cent so far this year, joining a parade of much improved results in the value community. But in his favourite playground, small-cap stocks have been on a tear, far surpassing the performance of their large-cap cousins and prompting market watchers to label this a monumental “junk” stock rally. Pint-sized U.S. equities have shot up nearly 70 per cent since the March lows to their highest level in 13 years. And it's being led by still-wary investors who have little faith in the market's long-term prospects. A long-time Wall Street observer exclaimed last week that he's never seen so many fully invested bears. One U.S. fund manager recently called it “dumpster-diving” by people who have scant interest in the stock fundamentals so fervently embraced by Mr. Michael and other value types. Who cares about, say, the quality of earnings when there's a hot trend to chase. Doesn't that make it tougher for long-term value investors to find the underpriced bargains that are their stock in trade? “It's not easy,” Mr. Michael acknowledges. “It was probably easier in March, when you could look at 10 stocks and buy five or six. Now, you're looking at 10 and maybe buying one or two. They're no longer dirt cheap.” But he'll take this pricier, more liquid and volatile market any day over what he faced in the dark days of last fall and winter. “If you're a disciplined value investor and someone has taken up your stocks far too much because there's insanity out there, you'll be supplying the stock to the marketplace.” And for a buyer, those shorting speculators can make for a good source of supply. “We're looking at fundamentals – book value, breakup [value], management. People who are working with squiggles on a chart or some computer program take a completely different tack. If they're taking the other side of the coin, that's fine with us.”