Five Tips From Pabrai For Finding 100-Baggers Pt. 1

How to find 100-baggers...

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Jun 26, 2018
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Finding a 100-bagger is every investor's dream. But finding these rare beasts is not a precise art, nor is it easy. It requires patience, analysis and, above all, skill to know when to buy, hold and sell.

Mohnish Pabrai (Trades, Portfolio), one of the world's most respected value investors, knows a thing or two about finding undervalued stocks that are set for huge returns. His book, "The Dhando Investor," concentrated on this topic, and he's built a career around finding stocks with enormous upside potential but minimal downside risk.

Pabrai has spent a career looking for equities that have limited downside but a substantial payoff in the best-case scenario -- classic value investments that look cheap and have a highly attractive risk/reward skew.

Looking back at his most successful investments, Pabrai said that there are five separate buckets potential 10 to 100-baggers fall into. He presented these findings in 2016 to students of the Guanghua School of Management in what was the first Value Investing Course ever to be held in China. The course was sponsored by Himalaya Capital.

Five ways to find 100-baggers

The first of the five categories is probably the most well-known. Companies that have "tailwinds" or, to put it another way, companies that have a significant structural or economic advantage working in their favor:

"There are about five different categories that these 10 to 100-baggers fall into...The first category of companies that has the potential for 10 to 100-baggers are businesses that have huge tailwinds. Tailwinds means they just have all the factors moving in their favor, they have very deep moats, they have very long runways, they have a very high return on equity, they typically don't need any debt, and the most important condition, an idiot can run these companies. Like Warren Buffett (Trades, Portfolio) says, "Invest in businesses that an idiot can run because one day an idiot will run them."

The second category isn't as well-known. Buffett's quote about investing only in businesses that can be run by idiots, as mentioned above, is well-disseminated, but some companies cannot be run by so-called idiots. Some enterprises require skilled managers to generate the best returns for investors. And as long as the right managers are in place, then these companies can also work out to be multi-baggers, although having the combination of a great business and great management is extremely rare.

"The second is exactly like the first except these cannot be run by idiots. These are businesses which are exactly like the first kind. They have huge tailwinds, they have deep moats, they have ultra-long runways, they have high ROE, they don't need any debt but they need great management, and they do have great management. These are businesses like Amazon, Costco, GEICO...These are all great businesses but they do need solid management on top of them to make sure that they can keep those franchises. But these businesses have economics that are just phenomenal, just great economics."

The third and final category of 100-baggers is the category of confusion. Here's what Pabrai had to say on the topic:

"The third one is when the market gets confused between risk and uncertainty. When you find a combination of low risk and high uncertainty, that combination is usually going to give you a high reward because markets are not very good at pricing in uncertainty. They hate uncertainty."

And to add some meat onto this slim definition, here's how fund manager Whitney Tilson (Trades, Portfolio) described the need to untangle risk and uncertainty in 2008.

"Wall Street in the main hates uncertainty, which manifests itself in depressed share prices of companies whose prospects lack “visibility.” But where the market can err is in confusing uncertainty with risk. Just because a company’s future is highly uncertain doesn’t mean an investment in it is risky. In fact, some of the best potential investments are highly uncertain, but have little risk of permanent capital loss."

Disclosure: The author owns no stock mentioned.

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