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Value investor Sarbit hopes his returns are worth the wait

'Leap of faith' required, researcher says

WINNIPEG -- In his Winnipeg office, Larry Sarbit seems out of place. The furniture at Sarbit Asset Management Inc. is up-to-the minute corporate chic -- high-tech lighting, a Bloomberg terminal glowing on the curved desk, avant garde art on the walls and muted carpets on the floor. But Mr. Sarbit, dressed in a turtleneck, is an iconoclast in the world of investing; he refuses to diversify away from a handful of companies that meet his standards.

By reputation, he is famous -- or infamous -- for holding substantial amounts of cash until the right opportunities come along, steadfast to the principles of value investing invented by Ben Graham and echoed by Warren Buffett, the Oracle of Omaha. "There are times you can only get a T-bill return," Mr. Sarbit says. Currently, his lead fund, the Sarbit U.S. Equity Trust, holds 40 per cent of total assets in cash.

Mr. Sarbit does not have Mr. Buffett's international stature, nor, with $67-million in his U.S. stock fund, the grand man's billions. But Mr. Sarbit does have a reputation for sticking to his principles of deep value investing. At Investors Group, his first gig as a portfolio manager, he racked up an average annual compound return of 18.6 per cent in the decade following the market crash of Oct. 19, 1987.

"I was supposed to take over in September, but I needed a month off," he says. "When I came back, the market had begun a recovery," he recalled. "It was my best timing decision."

The Sarbit style, which is resolutely bottom up, rejects market timing and macroeconomic forecasting. "We can't accurately and consistently predict the future [or] short-term moves in interest rates," he explains. "We cannot predict where stock markets will be tomorrow or five years from now."

What he can do, he says, is find companies with terrific fundamentals, particularly return on invested capital, that are priced at bargain levels. The method works over extended periods of time, Mr. Sarbit says. His mantra is a value investor's creed: "Eventually the market will see better numbers and the price of the stock will rise," he says. "But I can't say how long that will take."

The length of time it takes for markets to wise up to his wisdom is the essence of Mr. Sarbit's problem; the company's core U.S. Equity Trust, which completed its first full year of operation on Sept. 30, 2006, produced a 4.39-per-cent return, a hair below the 4.42-per-cent gain of the S&P 500 composite in the same period. Add in dividends and the comparison is worse -- the S&P 500 composite total return index in Canadian dollars was up 6.4 per cent for the 12 months ended Sept. 30.

Even patient investors may wonder if the Sarbit touch will work again. "In a larger company, there are resources that you don't have when you are on your own," says Dan Hallett, a mutual fund research specialist who heads Dan Hallett & Associates Ltd. in Windsor, Ont. "How much of Larry's 10-year record at Investors Group is his and how much is the analysts? Even if it is his record, there is a leap of faith that you have to make in his new venture."

The current investments in the U.S. Equity Trust are vintage Sarbit. Most are priced below book value and far below the average of other U.S. equity funds. The price-to-earnings ratio of the portfolio is about 75 per cent of its peers, the average market capitalization 10 per cent of its peers, the dividend yield significantly higher and the number of holdings -- about a dozen -- a small fraction of the 162 companies held on average by U.S. equity funds, according to Morningstar research.

The fund's portfolio is 40-per-cent cash. The rest is invested in stocks such as the following:

Clear Channel Communications Inc. (CCO-NYSE) is a San Antonio, Tex.-based broadcaster with 1,182 radio stations, 8.7 million billboards and 41 television stations. Shares purchased at $27.50 (U.S.), down from a peak of $95 in early 2000, closed at $21.30 yesterday. It has a 42-per-cent return on invested capital, Mr. Sarbit notes. "This is a cash machine."

SM&A (WINS-Nasdaq), a Los Angeles-based micro-cap purchased at a cost of $6.08 a share with no dividend, closed at $6.12 yesterday. The company is a specialist in putting together contract proposals for defence contractors. The firm needs very little capital and qualifies as a growth business at a value price, Mr. Sarbit says.

Foot Locker Inc. (FL-NYSE) is a New York-based retailer of athletic shoes with 3,900 stores in the U.S., Canada, Europe, Australia and New Zealand. Shares purchased at an average cost of $22.91 closed at $23.71 yesterday. The company's revenue thrives as young buyers, the core customers, purchase new shoes to keep up with fashion, Mr. Sarbit says.

Whether to buy the stocks or the manager is the issue. For Derek Moran, president of the advisory firm Smarter Financial Planning Ltd. of Kelowna, B.C., the choice is the man. "His track record speaks for itself. Analysts you can buy anywhere, but it's making the decisions that counts."

Sarbit U.S. Equity Trust

Leading positions (as of Sept. 30, 2006)

Foot Locker, Inc.8.68%
Clear Channel Communications Inc.7.76
SM&A7.12
Regis Corp.5.58
International Speedway Corp.4.71
School Specialty Inc.4.55
DTS Inc.3.95
Home Depot Inc.3.18
Collectors Universe Inc.2.86
Dover Motorsports Inc. 1.95

© 2007 The Globe and Mail. All rights reserved.

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