Mohnish Pabrai (Trades, Portfolio) is a legendary investor and the founder of Pabrai funds.
He is also famous for his charity lunch with Warren Buffett (Trades, Portfolio), which resulted in him becoming great friends with Charlie Munger (Trades, Portfolio). In a 2023 interview with the chief investment officer of Ironhold Capital, Siddharth Singhai, Pabrai discussed how he thinks about intrinsic valuation and some of his greatest investments.
When to invest
Quoting Buffett, Pabrai said, “We like to buy great businesses when they are on the operating table.” This refers to waiting for times when bad news has hit a business that does not materially impact its intrinsic value.
The guru also likes to analyze the “liquidation value” of a business, which is “relatively easy.” In a case when the liquidation exceeds the stock market capitalization, then this makes an investment undervalued.
Know your circle of competence
A key to making the investment process easier is to first understand your circle of competence, based upon the areas that you know. In general, most stocks should “fall outside your circle of competence.” An example Pabrai gives is the biotech industry, which would fall outside his area of expertise. Self-awareness of what you do or do not know helps to narrow down the universe of opportunities.
Steel company case study
A valuation example Pabrai gave was his previous investment in a steel company named IPSCO, which made tubular steel for pipelines.
The business had multiyear contracts, which gave “multiyear visibility” into future earnings.
In 2004, management announced that the company would make $15 per share in net income after tax. The stock was trading at around $45 per share at the time. In addition, it had $15 per share in cash on the balance sheet, with no debt. IPSCO also had lots of other assets, such as plants, etc.
Therefore, Pabrai assumed that over the next two years, the “cash on the balance sheet would equal the current stock price.” The business was cyclical, which was a risk, but he still decided to buy and hold it for two years.
Shortly after the stock went up to $60 per share and then $90 per share. Then a Swedish company announced it was buying the stock at around $160.
Therefore, the guru made a substantial gain of 255% on the stock.
Reysas
Pabrai also discussed a Turkish warehouse company named Reysas (IST:RYSAS, Financial) that he invested into in 2019. The company had 12 million square feet of “Class A warehouses.” which were “leased at a 99% rate.” These were also 10-year inflation-indexed leases, which means they were immune from the rampant inflation rate that has plagued Turkey’s economy.
Its market capitalization was just $20 million at the time, but its liquidation value was “over $1 billion,” with just $200 million in debt. Therefore, Pabrai said the intrinsic value was $800 million, which was the equivalent of buying a stock at “3 cents on the dollar.”
Since that point, the share price of Reysas has increased by over 800%.
Rain Industries
He then moved on to India-based company Rain Industries (NSE:RAIN, Financial), which is one of the world's leading producers of calcined petroleum coke, tar and various chemicals. The company has grown through a variety of acquisitions and is cyclical by nature.
Pabrai invested in the stock in 2018, when it had a market capitalization of under $200 million. He discovered that it earnings would “exceed $200 million” within the next few years.
Within three years, its earnings hit $200 million and the market capitalization rose to around $2 billion before correcting to $700 million, representing a substantial gain of between 250% (post correction) and a staggering 900% (at its peak).
This is a prime example of not knowing the exact “intrinsic value,” but realizing the chance of losing money is low.
How to screen for stocks
The investor takes a checklist-style approach to screening stocks in order to create a research list. He starts by asking if it is within his circle of competence, does he have insight, edge, etc. He also uses website write-ups and analysis for initial ideas to then research further.
Pabrai also likes to fish for ideas in less competitive markets such as Turkey. Many institutional investors considered the country to be not investable due to the rampant inflation rate of the lira (39% to 89%). This made the country look “optically cheap” to Pabrai. Therefore, he decided to contact a fund manager friend of his in Turkey and asked to visit the companies in his portfolio. This acted as a first “filter” for possible stocks to buy.
Then, the guru takes a disciplined approach to screening stocks and said if he can find just “two investments per year,” he is “doing well.” This is analogous to Buffett’s philosophy of waiting for the right pitch.
Investment partner
Munger informed Pabrai many years ago that it is important to “have someone to talk to” regarding investment ideas. Now, he actively seeks out alternative credible opinions on a company. This can help to bring the “error rate” down.
Position sizing is important
The guru has discovered from his analysis of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) that around one-third of its many acquisitions were not successful. Prime examples include many furniture retailers (with the exception of Nebraska Furniture Mart) and jewelry retailers. However, Buffett’s “larger bets” did pay off, and thus, on a dollar basis, the company has been tremendously successful.
Competitive advantages
The investor suggested looking at the products you purchase to find potential ideas as you will likely discover many companies with deep moats or competitive advantages. Examples Pabrai gives include rating agencies like Moody’s (MCO, Financial) and S&P Global (SPGI, Financial).
As for me, I can see Meta’s (META, Financial) social media-based network effects, Apple's (AAPL, Financial) brand and Amazon’s (AMZN, Financial) fulfillment scale.
Analyzing management
Pabrai said he believes it is useful to speak to management to find out the “key variables” that drive 80% of the business's success to ensure you are aligned. However, he does warn of speaking to “optimistic management,” who may sell you the best parts of a company. A better strategy is the analyze the track record of what management has previously guided for and achieved.
Final thoughts
Pabrai is an incredible investor and true thought leader. Intrinsic value can be an elusive topic, but having a basic understanding is vital in order to be successful as a value investor. In this interview, he gave us a glimpse into his thought process and how to simplify the intrinsic valuation of businesses in order to achieve success.
