Some of the most interesting commentaries from well-known investors were published during the financial crisis. During this period, when many investors were bailing out or rushing to cover cash calls as the market collapsed, the best value investors kept a cool head and talked at length about their process in letters to investors -- mostly to reassure them.
I recently stumbled across one such interview with renowned value investor Mohnish Pabrai (Trades, Portfolio). This interview was published in the fall issue of the Columbia Business School newsletter, Graham and Doddsville.
The whole interview provided some interesting insights into Pabrai’s strategy. However, some answers were more interesting than others. For example, when asked about how he thinks about downside risk, Pabrai gave the following response:
“At Pabrai Funds, I have made several mistakes in the past and I’m sure I’ll make several more in the future. You always need to protect the downside risk. I think margin of safety is one of the most important tenets that Ben Graham talked about. You always want to ask yourself 'What is my downside?' You also want to get some comfort that you have some protection. In some cases, you can get that comfort from liquidation value or hard assets minus liabilities. In other cases, you may get comfort from somewhere else. For example, if you look at a company like Moody’s or American Express, you couldn’t invest in these based on liquidation value. If their brands were permanently impaired, you would probably be losing money. However, as long as the brand continues to grow in value, you can end up making a lot of money. When you are looking at the margin of safety you can look at it in terms of hard assets like Ben Graham used to, or you can look at it in terms of more intangible assets which can be very valuable.”
The interview then moved on to the type of businesses Pabrai looks for when hunting for investments for the Pabrai funds.
“In general, I look for industries with a slow rate of change, companies with some type of moat, and companies with hard assets. I look to buy businesses where I can rest my hat on the hard assets of the business. Other times, I look at businesses that have more of a franchise value, so the intrinsic value is made up more of intangibles such as brand, etc. Basically, what I’m trying to do is find businesses that I can buy well below what they are worth. I usually try to make one bet per industry, and I typically put 10% of the fund’s assets into each idea. An ideal portfolio would be comprised of 10 positions from 10 different industries all priced at a discount to what they are worth. In terms of what exactly I focus on is determined by what is on sale.”
Finally, Pabrai is asked about mistakes, specifically, how does he try to avoid making mistakes? What is his process to prevent this sometimes unavoidable part of investing?:
“At all times, you have to be asking yourself the question 'What is the business worth?' and 'What is the intrinsic value of the business?' A couple of things can happen. First, you could have made a mistake on what you thought the business was worth and you could later have realized that it isn’t worth what you thought it was. In this case, you should look at the current stock price. The algorithm I use is to ask whether the current worth of the business is less than the current stock price. If the answer is yes, there is no question that the stock ought to be sold. On the other hand, even if I made a mistake, but the current value of the business is still above the current stock price, then I will typically wait for two or three years from the time I bought before I would think about selling. I’ll give the market some time to try to close that gap.”
Ă‚
Also check out:
