The Canadian equity market is a unique arena for value investors; commodity stocks and commodity derivatives (e.g., banks and industrials) make up almost two-thirds of the market. This concentration issue is exacerbated by the Canadian market’s cyclicality, interest rate and currency sensitivity, and illiquidity resulting from an abundance of small- and micro-cap stocks.

Perhaps no one is more experienced to deal with such a market as Bob Tattersall, a name synonymous with value investing in Canada. Now retired, Bob began his four-decade career at Confederation Life in 1970, co-founded the renowned Saxon Financial mutual fund family in 1985, and was most recently the Chief Investment Officer of Mackenzie Investments. In April, Bob held a seminar for CFA charterholders: Value Investing – A Practitioner’s Handbook.

There are many variations on value investing. Where do you fall on the spectrum?

My style is closer to the Ben Graham approach, which is based on hard data and statistics. What it lacks in vision, it makes up for in transparency, consistency, and defensibility. Whatever variation of value investing you employ, it forces you to be intellectually honest. I have no problem with other definitions of value investing. For example, Warren Buffett morphed from a purely numbers-driven approach to a more qualitative approach, and it worked out wonderfully for him. Not everyone can or should copy his approach. Regardless of the style you choose, stay consistent.

Do value investing principles apply similarly in Canada when compared to other markets?

Yes and no. The principle of paying less than what a business is worth still applies; however, the application is different. The Canadian market is homogenous in that many companies are commodity related. With commodity stocks, income and cash flow statement (price/earnings, price/cash flow) valuations are problematic because the denominator is largely based on your commodity forecast, which may often be wrong. Conservative balance sheet-based valuations (price to book value, price to tangible book value, price to net asset value) are best for commodity stocks, as they focus on the full value of the resource base rather than just one year of production.

What kind of success have you had investing in resource companies?

I have had mixed results investing in commodity producers. I have had more success investing in commodity derivatives such as energy service stocks—companies that are involved in site remediation or that own drilling rigs, for example. Commodity producers rarely create sustainable value and typically consume capital. Derivatives usually have an asset value that does not deplete rapidly, can be valued, and can be monetized.

Do you use macroeconomic analysis in your investment process?

Macroeconomic data are problematic because you must have a non-consensus view—otherwise, it is already priced into the market. If your view is in line with consensus, then you have to be right in how you apply that to your portfolio. I am not saying it is inappropriate, rather it is difficult to be consistently right. I invest in statistically cheap companies on a fundamental, bottom-up basis. By going wherever the data lead me, I can construct a portfolio of stocks with characteristics that have statistically led to good returns over time, regardless of the macroeconomy, management, or industry.

How has the practice of value investing changed over your career?

The philosophy of value investing has not changed; however, the universe has. Computer screens and databases are easy to employ, making it easy to find statistical bargains. Thus, the market has become relatively efficient. When I started in investing, you could find statistically cheap stocks that were legitimate businesses. Now, deep value screens produce perennial dogs—illiquid, microcap companies that usually have real issues. Now it is harder to find an unimpaired company that could potentially return to favour. On the other hand, quality micro-cap research has largely disappeared, thus making some opportunities still possible.

What is your investment process?

In concept, it is very simple. I run an initial screen, which lets the data speak to me. I look at book value and return on equity and ask what multiple on net worth I would pay for the business. Then I buy only if the business is selling at a fraction of that. In practice, it is harder than this because businesses change. Thus, I try to ensure the business is sustainable or can be turned around. Valuing stocks using normalized valuation multiples is important as well.

What characteristics make for a good value investor?

You must have a work ethic and a love for numbers and bargain hunting. The business of combing through financial statements and finding cheap stocks has gotten much more competitive; you must understand when you have done enough work and know when to act. You must also be emotionally stable and independent, and have an edge by bringing something unique to the table.

“Regardless of the style you choose, stay consistent.”

How do you look at risk as a value investor?

Individually, each company may be risky because it may have a single plant or product line. This is why diversification is important. On the management side, I believe in avoiding management that has had a poor track record, but I also do not pay up for superior management. If a stock is statistically cheap, then the quality of management almost doesn’t matter. At Saxon, we compiled a portfolio of these stocks that had limited correlation to the markets or macroeconomy. Our standard deviation was close to the TSX but low relative to investors’ perception of small caps, thus anecdotally confirming that value investing in small caps is less risky.

What career lessons do you apply to life?

Wherever you are in your career, keep your head down and do a good job with what you have. In life, if you simply deliver on what you promise, you will eventually be rewarded. While value investing is harder than it was 40 years ago, it can make for an intellectually stimulating and rewarding career.