Mohnish Pabrai on Intrinsic Value, Idea Generation & Moats
Investor takeaways #3
Disclaimer: This article is for informational and educational purposes only. Do not interpret anything below as financial advice. Always do your own research & speak to a financial professional before making investment decisions.
In a recent Q&A session with Ironhold Capital, Mohnish Pabrai provided some wisdom on intrinsic value, idea generation and identifying moats among other investing topics.
Source: YouTube
Intrinsic value
“The definition of intrinsic value is relatively simply. Calculating it, in most cases, is far from elementary.” - Mohnish Pabrai
Projecting cash flows is tough.
Below are some investing hacks we can use to help with the process.
Hack #1 - Circle of Competence
Most stocks are likely to fall outside of one’s circle of competence.
That’s fine.
Mohnish steers clear of BioTech companies for this reason.
Stick to companies within your circle. You are more likely to understand the intrinsic value of these companies.
Hack #2 - Be approximately right, not precisely wrong
We don’t need a precise number when calculating intrinsic value.
We just need to know the value above which will provide satisfactory returns. For instance, one should dig deeper into a stock trading at $50, where intrinsic value is ‘somewhere over $80’.
Hack #3 - Liquidation value
Arriving at liquidation value is a relatively straightforward process.
If the liquidation value exceeds stock price and is unlikely to go down you can assume downside risk is protected.
Reysaş Logistics is the largest warehouse operator in Turkey. When Pabrai invested, the company had a market cap of $20 million. He’d concluded its liquidation value was over $1 billion. With $200 million of debt and a net liquidation value of in the ballpark of $800 million, Mohnish paid around $3 cents on the dollar.
It was a no-brainer type deal.
Takeaway: if you need Excel to figure out intrinsic value there is a problem.
Idea generation
Investors have a 50,000 stock universe to choose from.
To reduce this initial dataset, some initial questions investors can ask are: is the company within my Circle of Competence? What is the valuation?
Further hacks to source ideas include:
Only buy businesses that have a write-up on VIC.
Study superinvestor moves via 13F filings published on Dataroma.
Read Barron’s.
Talk with friends about their portfolios. Mohnish’s trip to visit his friend in Turkey in 2018 and 2019 resulted in his Reysaş investment.
Aim for 2x investments a year. To put things into perspective, Mohnish found one investment during first 8 months of 2022.
Wait for something to hit you over the head like a two-by-four.
When it does, dig further.
Takeaway: Slow down.
Avoiding biases
Investors should always have someone to bounce investment ideas off.
John Templeton suggests a third of investments do far worse than expected. If investors make two bets each year, by the end of the third year, two won’t have played out.
In the case of Warren Buffett at Berkshire, out of 80 acquisitions he’s made at the helm, easily more than a third didn’t go the way he thought they would. What’s important is that those larger ones often were exceptional, dollar weighted bets.
If all bets were of equal weighting, however, the returns would not be as good. By surrounding himself with objective people like Charlie Munger, Warren was able to remain objective before making a fat pitch.
Takeaway: Seek out differing opinions to reduce error-rate.
Identifying moats
Moats become obvious to you if they are within your circle of competence.
After initial identification, begin to confirm your hypothesis by crunching the numbers. Wonderful businesses generate high ROE and without drawing out too much debt.
Starbucks is a fine example.
They make all their money back within first 2 years of opening a store in the US . Overseas, the payback is even faster, more like 15-18 months.
They have a 30+% ROE with a huge runway for growth ahead.
The products and services we use daily likely have wide moats. I mean, if you are buying the product in the first place there’s a sign it deserves a chunk of your cash.
Think razors, shaving creams, toothpastes, soaps, shampoos, cereals, clothes, cars - and so on.
Takeaway: Identifying a wonderful business isn’t too hard. The hard part is identifying a great investment.
Meeting management
Ben Graham always opposed to idea of meeting management teams. He sought methods more applicable to retail investors.
The dangers of speaking to management is that C-Level is usually rife with fantastic salespeople.
How are you going to disagree with someone who, at least in theory, understands the business far better than you ever will?
To avoid this from happening, investors should keep tabs on tangible metrics that highlight management’s effectiveness at deploying capital. Results are tangible. Forecasts aren’t.
Takeaway: Extrapolate data conservatively based on historic records.