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.
Dhandho 201:- Invest In 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.
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.
- If you read the business headlines on a daily basis you’ll find plenty of stories about publicly traded businesses. Many of these news clips reflect negative news about a certain business or industry. for example, Tyco’s stock collapsed when the Dennis Kozlowski scandal was front and center. Martha Stewart’s prison sentence clabbered that stock. More recently, Mr. Spitzer’s adventures with H and R block have led to significant declines in its stock prices. these were all headline stories.
- Value line publishes a weekly summary of the stocks that have lost the most value in the proceeding 13 weeks. it is another terrific indicator of distress. this list of 40 stocks routinely shows price drops of 20% to 70% over that period. the ones with the largest drops are likely the most distressed. It also has a summary every week of the stocks with the lowest price to earnings ratio (p/e), widest discount to book value, highest dividend yield, and so on. Not all these businesses are distressed, but if a business is trading at a p/e of 3, it is worth a closer look.
- there is a publication called portfolio report (www.portfolioreports.com) that is published monthly it lists the 10 most recent stock purchases by 80 of the top value managers. it gleans this information from the various filings that institutional investors are required by laws to make, portfolio lists the buying patterns of such luminaries as Seth Klarman of Baupost, Lou Simpson or Geico, Marty Whitman of Third avenue, Peter Cundall of the Cundall group, Bruce Sherman of private capital management, and Warren Buffett. these managers aren’t 100% focused on distressed situations, but they are focused on value. Distressed situations are a subset of value investing so some of their investments fall into the distressed category. (Good Business to Invest in Distressed business)
- if you’d like to avoid the subscription price tag for portfolio reports, then much of that data can be gleaned by looking directly at the public filings ( e.g. SEC form 13-F ) that Institutional investors have to make. these can be accessed on the EDGAR system ( HTTP://access.edgar-online.com) Alternatively www.nasdaq.com, provides much of the data in condensed form. to get to the data, on the Nasdaq.com main page enter the anyone ticker symbol of a holding you think one of the values investing stars hold. I know Marty Whitman of Third Avenue has Owned Teson Ranch (TRC) for many years, so enter TRC and click on ” Infoquarters” then click ” holding/insiders” then click on ” Total Avenue Management ” and You get a listing of virtually everything the third avenue owns in U,S, stocks, you can do a google search to get the name of the one ticker you need. e.g. If i enter ” Longleaf 13F ” into the google search field, i get links to many of its holding. I can use anyone ticker on Nasdaq.com to get to virtually all its U.S. Holdings.
- take a look at Value investors club ( VIC; www.valueinvestorclub.com) it is a wonderful website started and managed by Joel Greenblatt of Gotham capital. Greenblatt has perhaps the best-audited record of any unleveraged investor on the planet over the past 20 years- a compounded annualized return of 40% we delve more into Greenblatt and his Dhandho approach later in the book. Value investor club has about 250 members by presenting a good investment idea. these members are required to post at least two ideas a year. the quality of these ideas is decent as they are peer-rated. If a member presents shoddy ideas a year. He or she is likely to lose membership privileges. Every week the best ideas ( judged by VIC management) get $5000. the primary benefit of membership is the ability to access ideas in real-time. however, as a guest, you can access the same content with a 2-month delay. it is very much worth looking through VIC for distressed situations. Start with the highest-rated ideas and work downward from there. (Good Business to Invest in Distressed business)
- Last, but certainly not least, please read the little book that beats the Market by Joel Greenblatt. after reading the book, visit: www.magicformulainvesting.com Like Portfolio reports or VIC, not all the stocks on the magic formula, website are distressed, but a meaningful number are we delve further into the magic formula later. Between these sources, there are now a plethora of candidates distressed business to examine how can we ever get our arms around all of them? well we don’t, we begin by eliminating all business. that are either not simple businesses or full squarely outside our circle of competencies. what’s left is a very small handful of simple well-understand businesses under distress we are now ready to apply the areas o the Dhandho framework to the select group.
so this is all about the good business to invest in from chapter 8 of the book the Dhandho Investor