Richard howson is a bargain hunter, plain and simple. A long-time value investor and manager of the $380.5-million Saxon Stock Fund since March 1989, he doesn’t bother with top-down macro-economic calls or pay heed to hot sectors or the latest and greatest investment trend. For him, generating strong performance numbers is a matter of identifying cheap stocks and staying the course.

The approach has guided the fund to top-quartile performance over the past 15-, 10-, five- and three-year periods, Morningstar Canada data shows. For the 15 years ended Feb. 28, the fund had an average annual compound return of 12.7%, vs 9% for the median Canadian equity fund.
For the decade ended Feb. 28, it had an average annual compound return of 14.4%, vs 10.6% for the median fund. Similarly, for the five-year period, its average annual return was 16.1%, almost triple the median fund’s 5.3% average annual return. In the three years, it averaged 10.9% a year, compared with 8% for the median fund and, for the past 12 months, it was in the second quartile, returning 12.3%, vs 10.2% for the median.

The fund’s record can be attributed to two factors. “We have a low management expense ratio — 1.87% — that’s almost one percentage point lower than the median fund,” says Howson, 55, executive vice president and chief investment officer at Toronto-based Howson Tattersall Investment Counsel Ltd. Second, he employs a value approach to stock-picking and never wavers from that path.

“The fund has been managed in the same
style throughout the entire period — when value underperformed and when it outperformed. There has been consistency all the way through the piece,” he says. He has never owned high-flying stocks such as JDS Uniphase Corp. or Nortel Networks Corp., which eventually tanked. “It’s not that we bought stocks that have done superbly,” he adds. “It’s that we avoided making big errors.”

Howson uses a three-step investment process. Initially, he screens the Canadian market. “We’re looking for companies that are trading at statistical valuations — such as price/earnings, price/book and enterprise value/EBITDA — that are below the overall market. And we look at historical numbers rather than forecasts, because most analysts are fairly optimistic. It’s more likely that the results will be lower than forecasted earnings. We prefer to deal with the facts.”

Having narrowed the universe to about 200 companies, Howson conducts in-depth analysis of financial statements and, occasionally, visits companies in person.
His objective is to find out why a company’s stock is cheap. “Sometimes, there are good reasons; sometimes, there are bad reasons,” he says. As example of the former, the company could be in a cyclical industry and the market has marked down the share price in anticipation of a decline in earnings. “If the problems are cyclical and not specific to the company, we’d be willing to look through an industry downturn and buy the stock.” Conversely, a “bad” reason could be the discovery of possible environment liabilities which are not reflected in the balance sheet. “It’s only by visiting the company that you see the potential negatives.”

The second step involves getting management’s views of the appropriate valuations of companies in its industry, which helps him to value the firm. “I like to buy companies trading below their fair market value,” he says. “But that’s not always possible, especially today, when market prices are fairly high.” He unloads a stock when it reaches a 25% premium to its fair market value.

One example is Tesma International Inc. In March 2004, Howson took a position in the automobile transmission parts maker, a spin-off from Magna International Inc. He paid $30 a share. “Investors thought the auto industry was going into a cyclical decline and that car companies would put pressure on suppliers such as Tesma,” he says, adding that the stock was trading at four times enterprise value/EBITDA, or two full points below its private market value.
This past January, it was taken out at $41.80 a share, when Magna bought back Tesma. “I would rather have held on to it,” he says. (He voted against the takeover.) “We’re sorry we lost the stock.”

In a similar vein, the fund profited last year from Cott Corp. Howson bought stock in the soft-drink bottler in mid-1999 at $5.50 a share, after discussions with management about its plans to improve profitability. Cott delivered on its promise and even expanded through acquisitions and volume growth, and the stock became a favourite. In June 2004, Howson liquidated the position at $44.83 a share. Such big winners are rare, he admits: “Its valuation risk was high, so we sold our position.”