Hello friends, in today’s article we see chapter 8 of the book the Dhandho Investor author by Mohnish Pabrai, In this chapter the author explains, we should invest in distressed businesses, which is a good business to invest in. so let’s start to understand distressed business in distressed industries.
In starting this chapter the author explains, how efficient market theories works and how to affect people’s opinion on that. so let’s see one by one
the author says, ” Efficient market theorists (EMTs) tell us that all known information about a given publically traded business is reflected in its stock price.
then they proclaim that there isn’t much to be gained by being a securities analyst and trying to figure out the intrinsic value of a given business. and with frictional costs thrown in, the EMTs believe stock picking is not just a zero-sum game, but rather a negative-sum game. (Good Business to Invest in Distressed business)
Here are Mr. Buffett’s replies to them.
I’d be a bum on the street with a tin cup if the markets were always efficient investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards.
It has been helpful to me to have tens of thousands of students turned out of business schools taught that it didn’t do any good to think.
Current financial classes can help you to do average. … Warren Buffett
Mr. Buffett has been Cherry-picking stocks for 56 years and from a standing start has a fortune valued at over $40 billion today.
nonetheless, I mostly agree with the EMTs. Stock prices, in most instances, do reflect the underlying fundamentals, trying to figure out the variance between prices and underlying intrinsic value, for most businesses, is usually a waste of time.
The market is mostly efficient. however, there is a huge difference between most and fully efficient. it is this critical gap that is responsible for Mr. Buffett not being a street corner bum.”
then the author explains, how Warren Buffett writes a wonderful section on EMTs.
the author says, ” Buffett’s 1988 letter to shareholders of Berkshire Hathaway has a wonderful section on EMTs. I strongly recommend reading it.
All the shareholder’s letters are archived on the Berkshire Hathaway website and they are a treasure trove of wisdom. about EMTs Buffett commented: observing correctly that the market was frequently efficient, (academics and wall street pros) went on to conclude incorrectly that it was always efficient, the difference between these propositions is night and day.
-Warren Buffett
The market isn’t fully efficient because humans control its action-driven pricing mechanism. Humans are subject to vacillating between extreme fear and extreme greed. When humans, as a group, are extremely fearful, the pricing of the underlying assets, is likely to fall below intrinsic value; extreme greed is likely to lead to exuberant pricing. (Good Business to Invest in Distressed business)
If a business owner is extremely pessimistic and fearful about the future of his business and decides to sell it, it is likely to take him several months to get a sale consummated.
In the meanwhile, the circumstance causing the fear may have abated or, more likely, rational thinking is likely to have prevailed over time.”
then author explains, how individual investor mindset work in the market
the author says, ” In the case of the stock market, an individual investor in the same doom and gloom mindset would likely have uploaded his entire position in a few minutes.
Hence, stock prices move around quite a bit more than the movement in underlying intrinsic value. Human psychology affects, the buying and selling of fractions of businesses on the stock market much more than the buying and selling of an entire business.
Mr. Market, a creation of Benjamin Graham, lives in the stock market and is a very hyperactive and moody character. He’s buying and selling tiny fractions of several thousand businesses every few seconds.
The price at which Mr. market buys or sells is not based on the intrinsic value of the underlying business. It is determined by his mood. changes in his mood immediately result in prices changes.
Mr. Market’s Pari-mutuel approach to setting prices could not be more different from the way prices are determined for the sale of the entire business with the rapid-five trading of thousands of securities, every once in a while a few stocks might have a great deal of bad news, come out. (Good Business to Invest in Distressed business)
This sometimes leads to extreme fear and the wholesale unloading of these stocks, but when you sell stocks, there has to be a buyer at the other end. the buyer is looking at the same bad news as you are.
the only way such a sale gets consummated is at a deeply distressed price. Papa Patel, Manilal, and Mittal all made their fortunes by a fixation on buying distressed businesses.
Most of the time they did it when the entire industry was severally wounded- the motel industry right after 9/11 or the bankruptcy-ridden steel industry in 1980, and 1990.
The advantage we have over them is that our playing field is much larger; there are thousands of stocks whose prices wiggle around all day long.
All we need to do is to first narrow the universe of candidate business down to ones that are understand well and are in a distressed state.”
then the author gives the 6 points that help us to find out the distressed business.
the author says, ” How do we get a list of distressed businesses or industries? there are many sources, but here are six to begin with.
so this is all about the good business to invest in from chapter 8 of the book the Dhandho Investor
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