Value Library

The following is an excerpt from the ABC Perspective - July 1999 - Pg. 12

Patiently Thinking Small

As I sit at my desk during the sweltering heat of a mid-July summer day, my feelings are a combination of relief and gratification. Speaking as portfolio manager and major ABC Funds investor, our past patience is being well rewarded for having stuck it out with our methodical and disciplined value style.

I am not gloating about the ABC Funds’ recent top quartile performance. Instead, I am now looking ahead. I am now reflecting deeply about where the next surge of superior performance will appear. And I think I have found it. Having scoured through a very long list of U.S. and Canadian stocks I have noticed repeatedly that small capitalization companies, that is, under $250 million of market value in Canada and under $1 billion in the United States, have consistently exhibited extreme undervaluation.

Many of these diamond-in-the-rough small cap value stocks trade at significant discounts to book and net asset values, pay decent dividends, trade at under 10 times P/E ratios, have little institutional ownership, have a sparse brokerage analyst following and are very out-of-favour. In short, these stocks appear to me to be as cheap as the Internet stocks are wildly expensive. While I cannot pinpoint when these small cap value stocks will be discovered, I strongly feel that patience will be amply rewarded.

It is therefore of no great coincidence that our page four piece of Canadian and U.S. Small Caps-Diamonds in the Rough included 12 of the ABC Fund’s most undervalued holdings. All of these common shares are fundamentally cheap, North American, small capitalization value socks. Naturally we are quite optimistic on this group. But performance won’t happen overnight as in a number of these stocks we have been relatively early and lonely buyers.

By the way, there is a 1999 precedent for my optimism on small cap value stocks. Since the beginning of the year a number of our smaller company holdings have reached our elevated targets. We have liquidated these stocks at significant profit to purchase other undervalued companies, which have yet to perform. To use a chess analogy, we have sacrificed a rook to buy a potential queen. Canadian examples of recent sales include: Primex Forest Products, Scotts Restaurants, Cogeco Cable, Astral Communication and Newport Petroleum Corp. In the U.S. our sales include: Phillips-Van Heusen, Rex Stores, Smart & Final and Pioneer-Standard Electronics.

Overall, if I must offer my fellow ABC unitholders three words to describe our current equity investment strategy I would state that we are "patiently thinking small"!

Irwin A. Michael, CFA