World renown value investor and author Mohnish Pabrai presented The 10 Commandments of Investing at the Morningstar Investment Conference in Mumbai.
- Thou shall not skim off the top.
- Thou shall not have an investing team.
- Thou shall accept that thou shall be wrong at least 1/3rd of the time.
- Thou shall look for stocks with a hidden P/E of 1.
- Thou shall never use Excel.
- Thou shall have a rope to climb out of the deepest well.
- Thou shall be singularly focused.
- Thou shall never short.
- Thou shall not be leveraged.
- Thou shall be a shameless cloner.
Here we present details on three of them.
Accept that you will be wrong at least 1/3rd of the time.
If we are going to try to figure out the future of a business, what a business looks like 5 or 10 years from now, that type of an endeavor is going to have a very high error rate because there are lots of uncertainties that come in when we look at long-term futures of businesses.
Being wrong does not mean you lose money. You might have predicted a stock tripling in price, and it flatlines or maybe goes down 10% or goes up 50%. But you are wrong because it did not do what you expected it to. The good news is that even with a very healthy error rate, even if you are wrong 4/10 times, you are going to hit the ball out of the park.
If you are a brain surgeon, you cannot have a 40% error rate or a 4% error rate or even 0.4% error rate. But the investing business is very forgiving and tolerates a high error rate.
Look for stocks where P/E = 1.
To avoid confusion, P/E = 1 means that the company in the next one year earns what the market cap is, which is generally good for your financial health. So, let's say, I look at around 50,000 publicly-traded stocks and I run a screen to look at stocks that have a multiple of 40 or less. Probably tens of thousands of companies will fit that. As the noose tightens, (P/E of 30 or 20 or less), that number is going to keep going down.
Stock markets are auction-driven markets where mispricing is the norm. Ever so often we get mispricing which is very much in the buyer’s favour. Sometimes it's in our favour as sellers where things get very euphoric. So, generally, when things get very pessimistic, we want to be buying and when things get very euphoric, we want to be selling.
When I look back over the last 19 years, there has been at least 6 or 7 of these hidden P/E = 1 that have shown up in the portfolio. So, they are not very common. My personal experience is that they show up probably every 2 or 3 years. Generally speaking, one can do really well if one is attuned to looking at these types of businesses.
For instance, around 3 years ago, I invested in Rain Industries. The company earns around $2 billion per annum in revenue and in 2015, the market cap was about $180 million. They were trading at like one-tenth of revenue with PS = 0.1, and around 10 or 15 times earnings. But the business had some cyclicality to it. They were sitting on a multi-year low in terms of the cyclicality and there were a number of market forces that were likely to get them to a very different sort of earnings in a few years.
My best guess was that the odds were high that by 2019, the company's EPS would exceed the company's stock price, always a nice thing. And actually, now we're in 2018 and it's I think approximately true. I think they now make something around Rs 10/quarter or maybe Rs 35 – Rs 50 per annum, and we bought it between Rs 30 and Rs 45. So, the 2015 stock is at 2019 at a P/E of 1.
Be singularly focused like Arjuna.
In the story from the Mahabharata, Dronacharya places a pole in a pool of water with the instruction to shoot at the center of the eye of the fish. He asks the princes what they see. The describe what they see. But Arjuna says he can only see the center of the center of the eye of the fish, and with his bow and arrow takes the eye out. That's what we want to do in investing.
There is a lot of noise. Price of Brent. Fed tinkering with the rates. Currency depreciating. What we care about is that Rain Industries is at $200 million market cap and in a few years could be making $200 million; everything else is irrelevant.
What we are trying to get done is identify businesses that are within our circle of competence, figure out what they are worth and then if they are available ideally in this environment for one-fourth or less than what they are worth, let's do something.
