Of all the investors who claim to be value investors today, Mohnish Pabrai (Trades, Portfolio) has to be one of the most genuine. Pabrai's whole investment strategy is based around stocks with a price-earnings ratio of 1. To put it another way, he's interested in investments that are so cheap he'll make money even if they don't work out.
This strategy, which he's named "head I win, tails I don't lose much," has helped Pabrai carve out an impressive performance record. Since its inception (June 2000), his flagship investment fund has doubled the annualized return of the S&P 500 index, although his concentrated investment approach has come with some volatility.
In the fund's 2015-2016 financial year, for example, it lost 30% as one of its largest holdings, Horsehead Holding (OTCPK:ZINCQ), turned sour. From 2007 to 2009, the fund lost more than 50% of its value, although it soon rebounded.
A lucrative bet
One of the value manager's best-performing positions in recent years is Fiat Chrysler (FCAU, Financial).
Pabrai first added Fiat to his portfolio in 2012 and built a substantial position over the following years. He believed the company was one of his "price-earnings of one" stocks -- so cheap he would profit no matter the outcome. He talked about the valuation in an interview with Forbes Magazine in 2016:
"Fiat has guided for $4.50 a share in earnings in 2018. The stock is about $8 and that's a price-earnings multiple of 2. What do I think the company is worth? At some point probably in the 2018 to 2020 time frame the company is going to sell itself. It will be very surprising to me to find Fiat not trading for at least $20 a share by 2018. If they do a deal, it would be north of $30.
"They have a parts business that is on track to produce $500 million in cash flow. That business is probably worth more than $5 billion, or something like 50% of their market cap. Fiat has an exceptional management that has taken steps, like spinning out Ferrari, to unlock value that wasn't visible to the market. They'll probably sell or spin off the parts business. If at some point they do something with Maserati or Jeep, the valuation goes above $20 to $30 a share."
As it turns out, this forecast was almost entirely correct, and Pabrai has been able to reap the rewards. According to his second-quarter investor letter, Pabrai Funds acquired its position in the automaker for around $6 per share in 2012. Of this price, Pabrai calculated that Fiat itself was worth around $3.50, while Ferrari was worth $2.50.
Huge payoff
Unfortunately, after Fiat spun off Ferrari, Pabrai decided to sell his holding in the luxury automaker, which, as it turns out, was a big mistake. The Fiat stub now changes hands for around $14 per share, although the two business are worth an estimated $31 per share according to his second-quarter letter.
Still, while Pabrai might have missed out on some gains from the Ferrari spin-off, he's still raking it in from Fiat. This year, the company issued dividends of $2.28 per share. That's compared to the $3.50 per share the investment manager paid for the Fiat part of the business back in 2012. Going forward, the company will distribute around 70 cents per share in 2020 and 80 cents per share in 2021, returning his entire $3.50 investment by 2021 through dividends alone.
Following this performance, Pabrai says he is lightening his Fiat position to take advantage of other opportunities.
Pabrai's experience with Fiat Chrysler is a lesson in how investors can make a lot of money by investing in well-run businesses in terrible industries as long as they buy at a cheap enough valuation.
Disclosure: The author owns no share mentioned.
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