Advice On Value Investing In Emerging Markets From Mohnish Pabrai

December 22, 2016

Advice On Value Investing In Emerging Markets From Mohnish Pabrai

  • Investing in emerging markets still offers 100-baggers, the problem is that most investors don’t stick with them.
  • Looking for 100-baggers can make your portfolio, but it can’t break it because you can only lose 100% of the investment while the upside is unlimited.
  • Great investments can be found everywhere, you just need to know what to look for.

Looking Around The World For Value

It gets harder and harder to find stocks that have positive future business perspectives, a low valuation, and a price to book value that gives you a margin of safety when investing. Therefore, it’s necessary to do some research on such investments at a larger scale, especially in emerging markets. One person who is a specialist on this is Mohnish Pabrai.

Mohnish Pabrai is an Indian American investor who managed to grow his fund at a rate of 26% per year between 2000 and 2014. He started investing by buying 10 companies in the U.S. and allocating 3% of his portfolio to stocks in India back in 1995. As the Indian stock market was still in its infancy then, most of his Indian portfolio went up almost 100 times. Unfortunately, he only held onto one stock that locked him in with a 100-bagger gain. So, that’s our first lesson in investing in emerging markets:

Stick To Your Winners

Investing in emerging markets is different than what we’re used in developed countries. For example, it’s difficult for us to understand that India still has many unbanked areas. Yes, areas where there are no banks. When a country like India reaches a global average level of development, many companies, even if bought just now, will become 10 or 100 baggers (stocks that go up 10 or 100 times) as people start using services we normally use every day. However, it’s very important not to sell those stocks in the meantime, this implies a decade long investment horizon.

In his recent speech at Peking University, Pabrai also described the kinds of businesses we have to look for in order to find 100-baggers.

Look For Businesses That Have Huge Tailwinds

A business with a huge tailwind is one that has a deep moat, long runway, a high return on equity, doesn’t need any debt, and where an idiot could run it.

A business that might look like it has huge tailwinds—but then, not all of them—is Uber. The company is growing, building a moat, and it has a long runway, but it doesn’t have any kind of return on equity as it’s currently losing money. According to a recent Bloomberg article, Uber managed to lose $2.2 billion on $3.76 billion in net revenue in 2016. So, as much as we all know Uber has many business tailwinds, don’t get blinded by them and instead look for the whole package.

Pabrai’s advice is to look for emerging market companies that have similar business models to the Coca-Colas of the developed world. There’s no point in reinventing the wheel, just look at what has worked well around the world and invest in the same principles. Be patient, and the laws of economics will do the work for you.

Understand When The Market Gets Confused Between Risk & Uncertainty

This piece of advice involves looking at book values and cashflows.

It’s simple, when you see a $10 bill selling for $5 or less, it’s time to buy it. Such an opportunity probably won’t be a 10 bagger, but it could easily be a two to four bagger which is also good, especially because the book value gives you downside protection.

Current markets, thankfully, give such opportunities often as most investors find it difficult to differentiate between uncertainty and risk. A perfect example was the 2016 commodities bottom. Short term earnings were uncertain, but many miners were trading at cash values on top of the fact that they were low cost producers. Eventually, such situations reverse and you find yourself with great returns with practically no risk.

figure-1-rio-tinto
Figure 1: Rio Tinto’s (RIO) performance in the last two years. Source: Nasdaq.

A company that also falls under this is, or was, Fiat-Chrysler (NYSE: FCAU), according to Pabrai. He made a statement that FCAU expects to have EPS of $5 in 2018 while the price when his interview was done in October 2016 was around $6. The 1.2 2018 forward PE ratio makes the company incredibly cheap due to so much uncertainty around 2017 earnings. Two months later, the company is already 50% up, not a bad call.

Pabrai expects FCAU to trade at 7 times earnings, so it’s still a potential 4 bagger, even if it’s already up 50%.

figure-2-fcau
Figure 2: FCAU in the last two years. Source: Nasdaq.

Another example that Pabrai has given is the shipping sector, where investors tend to believe that whatever is happening right now will also be happening forever. However, due to the bust and boom cycles in the industry, good and bad times alternate all the time and create great investing opportunities.

figure-3-shipping-etf
Figure 3: Shipping ETF (SEA) in the last 5 years. Source: Nasdaq.

Going Into Bankruptcies, Reorganizations, Public LBOs & Special Situations

Looking for these companies requires special knowledge like that of taxes, corporate law, and valuation of distressed assets, as well as plenty of time for analysis and research. However, you’re always paying a few cents to the dollar in order to minimize your risks.

Investments Where There Is Upside Without Downside

This piece of advice involves looking for companies that have many probable positive catalysts still not priced in so that if none of the good happens, the price doesn’t move much.

An example of such a situation that I personally like are miners where the mineral reserves are already worth more than the whole company so if nothing new happens, you eventually get your money back. However, if the company has a good exploration team searching for new deposits, the upside is unlimited.

Conclusion

The great thing about investing in general is that the downside is limited while the upside is unlimited. If you set yourself out to look for companies that offer you an opportunity for a 100 bagger return and decide to invest 1% of your portfolio per year in such a company, the most you can lose is 1% of your portfolio. However, if one of your picks develops into a 100 bagger, you have doubled the value of your portfolio.

In order to invest for 100 baggers, you have to follow the above described rules and discipline yourself not to sell at a 20% gain because then you’ll lose out on the 9,980% upside in front of you.

Another beautiful thing about looking for great investments is that you don’t have to invest today. You can find something you like, then look at that stock every month or so, and then buy only when the price is below what you would be willing to pay for it.

If you have the patience, you will surely be able to buy the stocks you love at a discount. You need only a few of them per decade to have stellar returns, so don’t worry about the ones that never reached your target buying price.

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