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How Pabrai Is Weathering the Storm

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When I sat down recently with famed value investor Mohnish Pabrai, I got a chance to pick his brain on everything from the short-selling ban to his recent lunch with Warren Buffett. In part one of this series, I'd like to share Pabrai's thoughts on the recent market turmoil, and how he's looking for bargain investments during these tumultuous times. Here's what he had to say.

We're living in very interesting times, but if you look back at the last 100 years and you look at all types of events that have taken place -- the Great Depression, two World Wars, the Korean War, the Vietnam War, many recessions, the oil shock and price controls [of the 1970s] -- the U.S. economy and the global economy have, over time, seen tremendous shocks to the system, and, amazingly, they just continue to chug along.

The key thing that I keep in mind is not to focus on current market shocks, but to realize that over the long haul, if you own stakes in businesses that were purchased at prudent prices, by and large, you'll do just fine.

The only change that the recent turmoil around us has caused is to make me completely ignore the financial-services space -- no long or short bets. I just leave that area alone. I throw it in the "too difficult" pile.

But here's the important part: Because of all the recent turmoil we've seen, there are some incredible opportunities outside the financial-services space. Right now, that's really the place to make some hay!

The biggest thing I've learned from Warren Buffett is, as far as possible, you want your investments to be total no-brainers. If you have to wrap your head around the situation, and think to yourself, "Well, I think housing construction might make a rebound," or, "I think GM (NYSE: GM  ) and Ford (NYSE: F  ) will start building better hybrid cars" -- when you start talking like that, you're almost defeating yourself.

For most of the stocks I look at, there's usually nothing that catches my attention -- nothing immediate that says, "I need to drill down here." I would say 99% of the stocks that make it to my list get a pass within two seconds. What I'm looking for is something that blows me away. It should be painfully obvious. I want to be completely blown away with what I see, or else I'm not interested.

I'm always looking at the bottoms list -- stocks that are [trading at] a low P/E ratio, stocks that are trading at a wide discount to book value, stocks that show up on, stocks that get written up on -- I'm looking at everything except financials.

The list that interests me the most is the "worst performing stocks" list. Of course, you have to be choosy. Right now, you'll find a whole bunch of financial names that deserve to be there -- Washington Mutual (NYSE: WM  ) , AIG (NYSE: AIG  ) , Fannie Mae (NYSE: FNM  ) , and Freddie Mac (NYSE: FRE  ) -- they all deserve to be there. Crocs (Nasdaq: CROX  ) is another that definitely deserves to be there.

Let me give you an example of the type of company I look for. Right now, I'm building a stock position. Cash on its balance sheet represents 90% of its market cap. It has a portfolio of public and private companies that are worth one-and-a-half times the amount of cash the [parent company] has. Just based on those two factors alone, you can buy the company for less than a 50-cent dollar. The third part of the equation is that it's run by people who are phenomenal capital allocators. These guys have banged out 30%-40% returns per year for a long time, and they plan on deploying the cash on the balance sheet.

From my point of view, if you bought this company and it only had the cash on the balance sheet -- nothing else -- you would probably do just fine. Even if they take that cash and make an investment that does very poorly, you probably won't lose money because it has the other assets that exceed the market cap.

If everything works out, it would not surprise me to see this stock trading at five or 10 times its current price in five years. If it doesn't work out the way it's supposed to, I'll still do fine. It's heads I win, tails, I don't lose that much.

Too bad Mohnish won't tell you (or me) the name of the company he's buying right now, but the lesson is as clear as it is basic: During these times of incredible uncertainty, it's as important as ever to keep but a few principles in mind: Keep it simple, have a margin of safety, and stay within your circle of competence.

Stay tuned. We'll have more from my interview with Pabrai later in the week.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Crocs is a Motley Fool Hidden Gems PayDirt recommendation. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (28)

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  • Report this Comment On October 04, 2008, at 10:19 AM, PrincetonAl wrote:

    Ok ... who wants to guess what the company is?

    Seems like its a distinctive enough descrption to guess.

    Liberty Media maybe?


  • Report this Comment On October 05, 2008, at 1:56 PM, Lanfranco wrote:


    could it be Enstar Group (ticker: ESGR)? It seems that also Charles Akre, of FBR Focus Fund, has buyed its shares recently. And it certainly has a lot of cash, with respect to its total capitalization. It also has a very good record, over the last 10 years.

    Any comments welcome.

  • Report this Comment On October 06, 2008, at 2:15 AM, valuefrog wrote:

    Clearly it's Fairfax Financial (FFH). Mohnish has owned this stock for some time. When this interview was done maybe a little more than a week ago, FFH was trading at around $220. It's up significantly since then, but still a bargain.

    I bought FFH when it was $117 years ago.

  • Report this Comment On October 06, 2008, at 12:23 PM, gaurav811 wrote:

    I would bet that its RHJ International.......reasons as follows:

    1) Its been listed on ValueInvestorClub

    2) Its Market Cap is close to the cash on hand

    3) Its portfolio is made up of assets which are 1.5 times the cash on hand and still extremely undervalued.

    4) Tim Collins has a record of giving 30-40% return over past decade or so.

    5) CEO(Tim Collins) owns 15% of the stock and is using the cash on the balance sheet to buy back stock.

    I own it and it is a no brainer stock.

    One more thing.......its listed on belgium exchange because they dont have to pay capital gains tax on realized gains there .......and the portfolio investments are carried on the book at cost and not the real market values since in belgium you have to pay tax on unrealized gains.

  • Report this Comment On November 01, 2008, at 11:38 PM, hustlehard85 wrote:

    I think he's talking about Berkshire Hathaway, since at the time of the interview there balance sheet was loaded with cash and Buffett is buying aggressively

  • Report this Comment On January 23, 2009, at 10:32 AM, sanserve wrote:

    More on "Crisis Investing":

    Crisis Investing - A Three-Pronged WCM Strategy

    One of the great things about being a professional investor is the opportunity one has to apply his or her long-term experience to the investment environment that is unfolding (or coming unglued) in the present.

    If nothing else, most successful investors develop a consistent strategy that allows them to take advantage of short-term changes and the opportunities that they create in a somewhat unemotional manner. You can always tell a "newbie" by a "let's see how you do for a year" comment, or a "what's hot" question.

    Wall Street would like us to ignore the fact that the stock market is a cyclical beast that changes direction periodically, and almost never at the turn of a calendar quarter or year--- cycles vary in length, breadth, and direction. Inevitably, less experienced investors get caught with their portfolio egos unprepared for market realities.

    Similarly, Wall Street would like investors to look at income securities (bonds, CEFs, preferred stocks, etc.) with the same analytical eye that they use for equities. They too are expected to grow in market value forever, even though it's the income that the investor is after. High total returns mean missed profit taking opportunities more often than they signal increased income.

    So as much as the wizards would like us to believe (a) that up arrows are always good and down arrows always bad, and (b) that they can get you safely hedged (protected) against the bad stuff with all forms of creative portfolio care products; its just never going to work that way.

    Cycles are a good thing. They cleanse the markets of both fear and greed residue, and (all appendages crossed please) this time, perhaps, they'll point out that both multi-level derivatives and congressional tinkering don't ever produce the intended results.

    Unfortunately, investors in general are a lot like teenagers. They know everything immediately; expect instant gratification; take unnecessary risks; fall in love too easily; ignore all voices of experience; prefer the easy approach; and feel that the lessons of the past just can't possibly apply to what's going on now. Duh, dude!

    That said, what can Joe the plumber do to protect his 401(k), IRA, or personal investment portfolio from the Bernies, Nancys, and Harrys that are waiting in ambush? How does he protect himself from unregulated scams, and Wall Street toxins now, and into the future?

    Well, it requires a slightly more mature mindset than the new media allows most investors the patience to develop, and an appreciation of the miracle drugs that have saved the lives of comatose portfolios victimized by the correction viruses of the past.

    What if: (1) In the 30's, you had purchased shares in from 20 to 40 prominent, dividend paying, NYSE companies, or even in October '87, or '97. Now, if you had sold all those issues that gained 10%, and reinvested 70% of the profits keeping a diversified portfolio of similar stocks, hitting "replay" religiously, how much more market value would you have today?

    What if: (2) At the same start date, 30% of your portfolio was placed in high quality income securities, and 30% of the income produced (and the remainder of that produced by equity profits) was reinvested similarly, how much more income would you have today than you do now?

    If you combined the two analyses, how much more working capital would be in your wallet? You would be amazed at the results of this research; it would lead you to these portfolio life saving, and KISS-principle preserving, conclusions:

    One: Every market up cycle produces profit-taking opportunities, and all reasonable profits should be realized--- in spite of the taxes. Two: Every market down cycle produces buying opportunities, and buying activities of three kinds must be continued throughout the downturn.

    Three: Compound income growth is a wonderful thing, so find investment vehicles that can be added to routinely and, if spend you must, always spend less than you make. Four: Unhappily, nearly all of your past decision-making has been back---wards.

    Just as the process described above is significantly more difficult to implement with mutual funds and other products, so too is the three-pronged strategy for dealing with market opportunities.

    Reinvest portfolio generated income in three ways, and leisurely according to your planned, working-capital-calculated, asset allocation. Good judgment and an awareness of overall industry conditions are always required:

    One: Add new equity positions, in new industries if possible, and keep initial positions smaller than usual. Never buy a stock that does not meet all Working Capital Model (WCM) selection criteria, and never stray more than 5% from your overall portfolio asset allocation guidelines.

    These acquisitions should be monitored closely for quick turnover, at net/net profits of from seven to ten percent, depending on the amount of smart cash (WCM again) in your portfolio.

    Two: Add new income positions when yields are unusually or artificially high, and watch for quick profits in this area as well. When yields are normal or lower than normal, diversify into new areas. For better results, do more "ones" than "twos" if possible.

    Three: Add to positions in stocks that have maintained their quality rating and dividend while falling 30% or more from your cost basis. If the addition doesn't produce a significant change in cost per share, return to "one" or "two".

    Add to positions in income securities to decrease cost per share and increase current yield simultaneously. Never allow a single position to exceed 5% of total working capital.

    When the going gets tough, the tough go shopping, avoiding the buy high, sell low Wall Street game plan.

    Steve Selengut

    Professional Portfolio Management since 1979

    Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

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