Value Investor Francis Chou’s Top Picks

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Francis Chou, of Chou Associates Management, was recognized by Morningstar with the Fund Manager of the Decade award in 2004. We track his quarterly 13F filings alongside those of hundreds of hedge funds and other notable investors as part of our work developing investment strategies (for example, we’ve found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year).

In addition, while we don’t recommend blindly imitating any manager’s picks, we like to see how individual filers are playing the markets by going through their top picks; this also allows investors to potentially identify ideas for further research. Read on for our thoughts on Chou’s five largest holdings as of the end of March or see the full list of his stock picks.

Trusting two value investors

Chou is a modest guy: his top pick was Berkshire Hathaway. Many value investors think that their own talent in picking individual stocks is good enough to avoid buying shares of Warren Buffett’s holding company (or, like us, they are concerned that Buffett’s successors might not prove as adept at managing the giant amount of assets Berkshire has).

At current market prices, Berkshire Hathaway is valued at a significant premium to the book value of its assets, with a P/B ratio of 1.4. Find Buffett's favorite stocks.

When it comes to “the Warren Buffett of Canada,” Prem Watsa, however, Chou apparently prefers to order a la carte: his second largest holding by market value was Watsa favorite Resolute Forest Products (NYSE: RFP), a $1.3 billion market cap company providing newsprint and other paper products.

Due to a struggling industry, earnings per share have not been particularly high recently though Wall Street analysts expect business to improve over the next year and a half with the result being a forward P/E of 12. According to the most recent data, 16% of the float is held short.

Three more of Chou’s picks

The fund owned 2.5 million shares of Dell (NASDAQ: DELL) at the end of the first quarter of 2013. Dell currently trades at around $13.42 per share, with the company apparently moving towards accepting founder Michael Dell’s offer of $13.65 (working with private equity investors such as Silver Lake) to take the company private.

Billionaire activist Carl Icahn has offered more per share, but concerns regarding the reliability of his financing seem to be preventing him from winning the deal. That makes for a 1.7% absolute unlevered return assuming the deal closes at $13.65.

Troubled department store Sears (NASDAQ: SHLD) was another of Chou’s largest holdings with the 13F disclosing ownership of about 680,000 shares. The retailer is unprofitable on a trailing basis, and is expected to be so next year as well (though losses per share are expected to be cut nearly in half).

Forty six percent of the float is held short as many market players are skeptical of a turnaround. In its most recent quarter, Sears’ revenue declined 9% compared to the same period in the previous fiscal year and with the industry as a whole struggling, we would avoid it.

Chou Associates Management had about 340,000 shares of Actavis (NYSE: ACT) in its portfolio as of the beginning of April. The pharmaceutical company, which is best known for its strength in generic drug offerings, has risen about 50% year to date and has been reporting good revenue numbers.

The sell-side is forecasting $9.55 in earnings per share for 2014, implying a forward price-to-earnings multiple of 13. This would be a fairly cheap multiple assuming that Actavis can convert its revenue into better earnings, and so we’d be interested in learning more about the company.

Conclusion

We’ve mentioned our concerns about Berkshire Hathaway and Dell, though investors who are more confident in Buffett’s ability to choose successors and those who are interested in merger arbitrage opportunities may want to consider those stocks as well as Actavis.

In the cases of both Resolute and Sears, we’re bearish on the industry and the individual companies have not been performing well enough recently for us to consider them as potential value plays right now.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in Dell. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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