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Collection: Mohnish Pabrai - #151 '4th Commandment of Investment Management'



Then we get to commandment number four, Thou shall look for hidden P/E of 1 stocks.

And so, you know, here’s the way the world works. So maybe there are around let's say 50,000 publicly traded companies globally and let's say I set up a screen which said I want to look at all companies that trade at 40 times earnings or less.

The odds are I’ll have, you know, kind of tens of thousands of businesses that will fit that screen. If then I change to a P/E of 30, I still have you know several thousand businesses, P/E of 20 still several thousand, P/E of 10 still maybe, you know, north of thousand maybe well above that. And as I keep tightening that noose you know, to P/E of 5, P/E of 3, P/E of 1. There will still be some businesses that’ll slip through.

Now those are the non hidden P/E of 1, but what we want to look for is the hidden P/E of 1 which means they are a P/E of 1, but they don't show up as such on a screen.

So for example, and they can be P/E of 1 based on future earnings, they may not be P/E of 1 on today’s earnings. I mean in 2012 when I invested in Fiat Chrysler, you know it was trading at less than 5 dollars a share and the company had forecasted in a few years – actually 2018 – that they would make about 5 dollars a share.

And actually as we are coming into 2018, you know they spun off Ferrari but if I include the whole pie including Ferrari they they exceeded that number. So what we paid in 2012, P/E of 1 materialised in 2018. And so the – I mean the end result is that investment went up 7 or 8x in that period.

So generally speaking when you do P/E of 1 in general good things happen to you. And another stock I think I'd mentioned in your class Arvind a few years back was IPSCO, it was a steel company.

And at that time I was investing in IPSCO I think it was 2004 or thereabouts, 2004-2005. And IPSCO was trading, if you just screened it, it was trading at 3 times earnings but one-third of the market cap was in cash.

And so if you kind of adjust it for the cash because they had basically they were trading at 2 times earnings and the earnings in the next two years with the company’s own guidance and such was what the company excepted to make in cash flow in the next two years.

And so basically you had a third in cash and the next two years earnings coming on and there was absolutely no visibility beyond the two years. So this was a very cyclical business, it was possible that after two years earnings would just fall off a cliff.

But my thinking then was that if we held the stock for 2 years we got all our money back and at that point, I just wanted to see what the stock would trade at, you know, it had to trade for something because it had all these huge plants and infrastructure and everything else.

And so what happened in that case is a year after I bought the stock, the company announced they had one more year of visibility and earnings were going to continue the way they had been happening which means now we had in effect 3 years of visibility so we were in the black. And then as we were getting close to 2 years, someone came and bought the company and we ended up with about of 4x return on the original initial purchase in less than 2 years.

And so anyway the P/E of 1 what I noticed is that in the last 19 years or so, that I’ve been running for Pabrai Funds its happened at least 6 or 7 times that we found P/E of 1 like Fiat Chrysler or like IPSCO, very early on I had invested in Steward Enterprises which was in the funeral services business that was that actually was sitting at a P/E of 2 in Value Line.

I opened up Value Line as I do every week, I always look for P/E of 1 in Value Line usually they are not there but you can find P/E of 2 quite commonly. Usually, those are businesses that are good to avoid but every once in a while there is a gem that shows up.

So, for example, the reason I was kind of interested in Steward Enterprises when it showed up is that they are in the business of burying dead people and then the funeral services business.

And one thing I read a lot time ago about funeral services business is out of all the business – SIC codes, you know, industry categorizations – funerals homes have the lowest rate of business failure.

So if you look across industries – across a number of any industry the lowest rate of business failure is funeral homes and the reason for that actually becomes obvious if you think about it.

So first of all, no one in this classroom – all of you gifted people is planning to go into the funeral services business, I can almost bet on that. There are no 22 year olds I know of who say, you know what I think I'm going to go into the funeral service business because it has the lowest rate of failure, it's such an awesome business that’s what I'm going to do. This doesn't happen.

So first of all, the people entering the business are few and far between and then the second is that when your aunt or uncle who you love so much passes away you don't go about seeking the low bid to have their last rides done.

You might at the most reach out to typically reach out to the place that ideally your family has been using for many generations and hopefully get it done that way. But even if that’s not that case you'll try to reach out to some neighbourhood funeral services operation and whatever they tell you, you are not going to start negotiating on the phone and you are probably not even making 5 calls to get the lowest bid.

So this is not a business where you are going to seek out unless you hated that particular relative. You are not going to particularly seek out a low bid. And of course, you got all the upsells with air condition coffins and everything else in between to make you feel really good.

And anyways so basically the hidden P/E of 1 is really good for your health and your financial health. I mean, and so looking for them is a great exercise.

And in fact, I just got back from Istanbul last night and I think it was only P/E of 1 that I visited, I was swimming in P/E of 1. It was quite the orgasmic experience. (Laughter) Anyways, so that’s commandment number four to go hunting for P/E of 1.


[YAPSS Takeaway]

4th Commandment of Investment Management: "Thou shall look for hidden P/E of 1 stocks."

Seek for the hidden gems and learning about the business at the same time, that's the fun of investing.

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