Last month, Mohnish Pabrai (Trades, Portfolio) published a Q&A session with Radhika Gupta, CEO of Edelweiss Asset Management. In the wide-ranging interview, the duo discussed several investment topics, but the current stock market environment took center stage.
Pabrai has been a professional investor for more than two decades, during which time he has seen at least two significant crises, excluding the current one. In one of the questions, Gupta took the opportunity to ask the experienced investor to explain what his biggest takeaways were from the 2008 financial crisis, and how those lessons have helped in the years since.
Pabrai on leverage
Pabrai responded by saying that his most important lesson from the financial crisis was to avoid companies with a lot of leverage:
"I think the number one area where I have had trouble in my portfolio has been making investments in leveraged businesses and buying leveraged financial institutions.
..In 2008 and 2009 - as you know I run a concentrated portfolio typically ten investments would make up more than 80% of assets - I had one investment which went to zero. That was a mortgage lender, and I had another one that almost went to zero that was also in the finance business. And those really hurt because those are a significant hit to the fund... it took us a while to recover from that....
So I think if the lesson I took from there is to stay as far away as I can from leveraged institutions and from leverage in general... I want to make sure that even the businesses we get into typically are not in that space."
As the value investor went on to explain, according to his research, one of the primary reasons why some value investors do not succeed over the long run is because they invest in companies with too much debt.
Another significant factor in the underperformance of individual investors studied, according to Pabrai, was "moat misunderstanding." However, leverage was by far "the biggest one," he went on to add.
Building a framework
This could provide an excellent framework for value investors looking for potential investments in the current environment.
After talking about his investment strategy, Pabrai went on to give some of his views on the current market environment. He explained that the market is currently pricing in the best-case scenario, and this could cause problems later in the year. The value investor believes that the market is currently pricing in a vaccine being discovered this year, which is highly unlikely based on data from the past. "Historically humans have not produced vaccines this quickly," he noted.
He went on to add that the current market looks a lot like 1999. Back then, equities were very heavily "polarized," where just a few stocks attracted all the money:
"We see something similar now at least in the U.S. markets where there's a lot of money going into the FANGs and the Teslas and such. And you know some normal brick-and-mortar businesses, I think they are decent value."
These comments suggest that Pabrai believes the market is overvalued in some sections, but other parts offered tremendous value. Unfortunately, he didn't provide any insight into the types of companies he thought looked undervalued.
Nonetheless, his comments do provide some framework for investors to work with. Undervalued real estate plays with lots of hard assets and not much debt may be the sort of businesses that this highly regarded value investor would consider buying in the current environment. However, they would have to be deeply undervalued to make it into the portfolio, as well as easy to understand.
On the other hand, it's also clear that he's going to be avoiding the FANGs for the time being.
Disclosure: The author owns no share mentioned.
Read more here:
- Cruise Companies: Value Trap or Value Investment?
- Mohnish Pabrai: Even With Great Companies, Valuation Matters
- Berkshire and Utilities: More Deals on the Way?
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