returnonmycapital

Out with ABC Funds and in with Chou Funds. Chou RRSP Fund has established a position in E-L Financial with an approx. cost of $470/sh.

My problem is today you could close your eyes and hit a cheap insurer. Not in CAD you can't. And for anyone like me, whose base currency is CAD and has watched as their defensible US holdings' returns have been severely hampered by an 8yr crumbling of the USD/CAD exchange rate, decent CAD investments are few and welcome.

I too believe that what Sanjeev is doing here is very important. I owe a great debt to you all, I have learned much and look forward to continuing to do so.

glider, Your estimates and mine are the same (and I think they are conservative too). With those estimates, we are suggesting a 12-13% economic return on today's market price. Their historical average experience is 3%+ better than our estimates which translates to 17% return on today's market price. Positives (IMO): Common equity investments account for almost 90% of book value. Float has increased about 9%/yr over the last 5 years (FFH = 7%/yr and BRK = 6%/yr). Cost of float at ELF has averaged less than 1%/yr over the last 5 years (FFH = approx 5%yr [sorry] and BRK = -1%/yr) As a result, operating margins have averaged 11%/yr over the last 5 years, despite a rubbish -1% in 2009 (FFH = 2.5% and BRK = 12.6%) Management/majority shareholder keeps buying shares, albeit through indirect means (because it's much cheaper to do so - I mean, wouldn't you? And these indirect vehicles are available to us as well Tickers: UNC/EVT). P/BV is .6X my 2010 estimate (FFH = .9X and BRK = 1.4X) Negatives (IMO): Their annual report is unapproachable for all but the most insomniac. They aren't up to the same quality as FFH/BRK in investment management and will probably do only a little better than the market given their stable of fund managers. Steps they are taking to improve: They have started reporting book value more the way we would like to see it. They acknowledge that the lawyers/accountants write the annual letter and have taken it under advisement that it would help to 'humanize' it. They read BRK/FFH annual letters and do understand there is a difference. They have moved almost all of their investment management to value-based rather than growth.

The discount & management reporting are issues of note, but they have little to do with the actual business and its returns to shareholders. I am looking for a return on my capital, which means I am looking for a business like ELF to generate comprehensive earnings that I can acquire at an attractive yield to me. ELF has grown its "Retained earnings" and "Accumulated other comprehensive income" per share at about 11% per annum since 1998. I argue that this is the most important figure to focus on as it eliminates share issuance at premiums to book, etc. which do not really show how management runs the underlying business. I add back dividends paid to this figure when calculating total Retained earnings and Accumulated other comprehensive income per share (but I do not compound the dividends). I arrive at a ballpark figure of $$688/sh as at Dec. 31. At a price of $440, or 0.64X, and if the future is somewhat like the past, I may earn 17% return on my capital per annum over time. That's better than a kick in the teeth. I don't speculate as to whether the discount will widen or narrow, I just know that with present management and with such a market price, I should do pretty well. I would also argue that management's recent and expected continuing disclosure of its Net equity value goes quite a ways in improving its reporting and simplifying of its business to shareholders. It doesn't even incorporate the discounts of price/book value of its equity method investments - which I last suggested were worth about $35/share extra. And just as an aside, they had a combined ratio of 114.5% in their P&C division last year. That equates to a 3% cost of total float. Their Net equity value per share increased 25% despite this 'calamity'. They are calling for a hardening market in Canada in 2010. They are not Kingsway, I think they prefer to tell shareholders negative news. All in, I think I'll do ok.

Francis does use Citibank but he gets charged only 0.10% with something like 60,000+ investors, if memory serves. Citibank answers the phone with "Chou Associates..." which is a higher level of service than Commonwealth offers me. But they do want Francis' business, so maybe they would step it up for him. I use Burns Hubley for audit and Owens Wright for legal, like Francis. In fact, Francis is really responsible for my fund, he's the one that kicked me in the pants to start one. I have had NAVs come in two weeks after the valuation date. But, I don't have any real time constraints and they know that so I imagine I am the last guy they work on. They have some much bigger clients who use daily NAV so I imagine you won't have too much trouble. I imagine they would handle out of province funds. Give Alex a call.

Parsad, I do use Commonwealth and I am happy with their service. Alex Chapman is my main contact and is a straight-up guy and I trust him. He has a good team and I like them. Commonwealth is fairly new, when I started my fund it was when Alex was with Mintz. So, there have been some kinks as new people are brought on board and systems are built, but I have had no material issues to report. It just took a little longer to do the NAV than I would have thought on a couple of occasions. The 0.2% includes admin, tax prep, mailings, provincial reporting (I have only helped fill in 1 provincial reporting document). I email them my annual letter, they then mail out the annual report. I have yet to hear a complaint from any of the fund's owners with regard to their services. When doing the books, they are conservative - I use GAAP accounting (only bid prices), rather than transactional - for example.

I pay 0.2% administration (and that includes everything) on the first $10m, going down to 0.15% on the next and down to 0.1% after $20m. Other fees include $100 per investor annual maintenance and $50 per investor transaction. My fund's audit is only $4,000 per annum. On a fund of $10m+, I pay less than 30bps and do nothing.

ELF has come out with their annual report, available at http://www.sedar.com/search/search_form_pc_en.htm I found it interesting that they have started reporting the "Net equity value" of the company. In previous discussions, we have debated what the real book value is. ELF states it is $681.51 per share, as at December 31, having risen 25% during 2009. At a present price of $440, it looks a steal.

I should add that I believe common sense to be a combination of nature and nurture but drive is probably out of our control, it just seems inherent in those that have it.

Common sense and drive. If you have those, the rest will take care of itself. A CFA, an MBA, a job with a large money manager all will delay and/or hurt your ability to become competent. This is a lonely business, committees and consensus will only hurt your chances. And if you do manage money for others on your own, treating 'your business' like a business will also hurt you. Common sense and passion, that's it.

I posted a while back on ELF. In my posts I too made the assertion that since the company reported earnings on a "Adjusted Common Shares outstanding" basis (deducting indirectly owned shares in itself), that was akin to shares held in treasury. In that case, book value per share should be revised upward. However, I have since changed my mind. The reason being that if the indirectly owned shares were really 'treasury shares' then cash paid for dividends to common shareholders would be reduced, or Adjusted dividends per share should be higher. Example: Cash paid for dividends to common shareholders in 2008 = $2.01 million (equivalent to $0.50/sh on 4.019409 million common shares). The company should have paid only about $1.7 million in cash for $0.50/share on "Adjusted Common Shares outstanding". That, or a shareholder should have received $0.60/share in dividends on Adjusted Shares, if $2.01 million was paid out - which did not happen. The indirectly owned shares are collecting dividends 'outside' of ELF, therefore, those same shares are also collecting earnings 'outside'. To me, that means that the "Adjusted Common Shares outstanding" that the company states in its financial reporting is simply an accounting rule used to suggest a certain amount of control, but does not improve the economics for other common shareholders. That said, the company is still undervalued, in my estimation, just not wildly.

Selling GCI at $6-7/sh Not buying AXP at $10/sh (I was waiting for $8/sh, if you can believe that nonsense).

From the same article in the FT: "Net sales from central banks dropped 90% to 24 tonnes in 2009, the lowest level in more than two decades." But, central banks overall continue to liquidate gold.

"Source: Financial Times (USA), Companies & Markets, January 14, 2010, page 15." Sorry, should have included it originally.

An excerpt from a mutual fund report: "A popular ‘speculation’ today is gold. The metal’s present price does not seem to reflect economic reality. For one, its cost to extract and deliver in a purified state is well less than U$400 per ounce. That is to say, after all costs (exploration, expropriation, refining, delivery and all the associated expenses) gold is worth about U$400. Anything more and capital (i.e. shareholders) earn a return – which invariably will not be paid out to them, making it of little use. Secondly, the supply of gold is outstripping its demand. Approximately 4,100 tonnes was supplied to market in 2009. Demand for the metal was around 3,500 tonnes of which about 1,680 was for jewellery and 1,820 tonnes was for ‘investment’. That leaves at least 600 tonnes without a home. 2008’s imbalance was little different and yet the price of gold has continued skyward. It makes me giggle to think of what the CEO of a successful mining business said to me over dinner not long ago: “Buy gold? Why, I have only ever made money selling gold.” Gold is just one example of the stampede of speculative savings into all things extractive: Oil, grains, coffee, copper; the list goes on. If you can farm it or find it, it has value. It’s a return to the good old days of hunting and gathering. Tomorrow, however, is another story. Imbalances correct, bust typically follows boom and speculators’ savings magically transform into promoter bonuses, for the good of their Porsche dealer, of course."

The repayment should allow for a dividend increase. Perhaps up to $1 from the current $0.20 (annualized) in 2010; equivalent to a 4% current dividend yield. I see as much as $2 of current dividend paying capacity when provisions normalize.

bernard, I gotta say, I actually feel more confident after my discussions with ELF. They are conservative, to the point where it seems unnecessary. I can see where you are coming from, it does seem a bit confusing. But, as the CFO suggested, he is just playing by Canadian GAAP rules, he didn't make them up. And ELF has been very good at investing in themselves at the cheapest price - that appears to be where the complications sprouted from. I have no problem with that.

bernard & woodstove, I checked with the CFO yet again and he mentioned my sums were incorrect w.r.t. the indirectly held shares. He said their cost is already reflected in book value because they have been netted out of each indirect investment on the balance sheet and the cost has been deducted from P&L with writedowns, as per Q3 writedown of EVT. So, there is no need to reduce the cost of the 700k shares, it has already been done. Effective book value is around $715 per share. I asked about IFRS and he suggested that nothing material will happen to the balance sheet. He said that Canadian GAAP accounting over the last couple of years has been tough.

bernard, 1) Yes, it is strange that GAAP requires them to deduct the indirectly owned shares for eps but not for balance sheet discussion, i.e. book value. They seem to want to rectify this. 2) EVT has 343,706 shares of ELF but ELF owns 20% of EVT, so 70,185 shares of ELF indirectly owned. 4) If you are talking about the Series A convertible preference shares, the CFO told me those date back many years and are not at risk of increasing. I have added them to the common share count, but that's only 258 additional common shares. If book value is close to what I suggest, it means that - based on current market value - ELf offers a historical return on investor's capital of 16% per annum, and 19%+ for 2009 ytd. I plan to continue to suggest that management improve on its transparancy and explanation of its logic to shareholders.

I spoke with the CFO and his responses were as follows: 1) Quasi-treasury shares: To deduct the cost of the 700k ELF shares indirectly-owned, use well less than $100 per share. He wouldn't tell me the exact number as it is not public information, yet. He does think he will add the information in the next and future annual financial statements. I am using $90/sh. 2) Economic Investment Trust (EVT): The charge is to reflect the deduction of the ELF shares indirectly owned by ELF due to its investment in EVT. It comes to a total of 70,185 ELF shares, valued as at Sept 30 at $29 per EVT share (34% of EVT is invested in ELF). Considering the writedown was worth $46 million, that suggests a value of $655 per ELF share written down. I will be asking him to confirm this value and my sums. 3) United Corporations (UNC): ELF owns 47.2% of UNC (up from 41% at the end of 2007). If they go over 50%, they must consolidate UNC and ELF book value reflects UNC NAV, not market. The effect is $20 per UNC or $120 million. They will still continue to be able to buy UNC shares on the market but they must reflect them at NAV in their statements. Pretty material accounting gain, if it happens. 4) Convertible, series 2 prefs: Convertible at ELF's option as early as October 2011. No plans to convert these shares. 5) Bond portfolio: The annual report states maturity profile and interest rate sensitivity for their bond holdings for each of their sections (corporate investments, general insurance, and life insurance). Given the above, I calculate effective ELF book value at $695 per share, up 13% ytd. ELF trades at 0.68X book value.

bernard, The CFO is off today. I will get in touch with him on Monday. To all, If there are any other questions, please post them to this thread prior to Monday morning so that I can bring them up at the same time.

Bernard, You make a good point with respect to the 700k shares effectively in treasury. To properly net them out, we must deduct their cost. I have put in a call to management to find out how much they cost. Again, you make a good point on EVT. The company told me that it accounts for its equity method investments as follows: At cost +/- future changes in NAV. ELF added EVT as an equity method investment at Jun 30 at a value of $78 million ($68/sh). At Sep 30, they show a value at equity of $46 million ($40/sh) when the NAV went from $74/sh to almost $86/sh. Only a small amount of shares were added during the 3rd quarter, so the cost argument (based on market price discount to NAV) is not valid. How did they manage to take such a huge writedown if NAV went up by 16%? Another question I will ask the CFO. I'll be back shortly.

Woodstove, I should also add that Burgundy Asset Management looks after some of ELF's equities. So, outside their managers are Jarislowsky Fraser (GARP) and ValueInvest (value?) at United Corporations, Sanford Bernstein (GARP?) at Economic Investment Trust, Burgundy Asset Management (value) at ELF, and an emerging market fund.

woodstove, In the financials on Algoma Central, they target a ROE of at least 10%/yr on avg. The stock is trading at about 2/3 book value. And they are taking on more ships in the next 1-2 years. A prospective increase business and a cheap stock add up. The chairman did point out to me the fact that they were adding to their holdings in Algoma Central, much like BRK is doing with BNI. But, at a prospective 15% earnings yield (on current business). Take into account the ships coming on and that may look conservative. bargainman, The closed end funds (United Corporations and Economic Investment Trust) are decent proxies for their equities. You can find their investments in their financials on SEDAR. In addition, ELF holds about $100 million in an emerging market fund. Managed by?