Collection: Mohnish Pabrai - #31 'Tradeoff Between Valuation and Growth'



I think it depends – It depends on the business but in general, It's a function of the growth so you know, growth and stability of cash flow to the equation.

But if you have a business that has let's say absolutely zero grow. It's just going to sit at the same level of cash flows but it has very high stability of those cash flows, kinda like utility almost guarantee to come in.

Then you know I would say a business like that is worth at least 10% I mean, at least 10 times cash flow you might go a little bit higher you know, very low interest rate environment might make it to 12-13 or even 14 times.

So I would said that a business like that is worth let's say 10 to 14 times cash flow. And so if you can get it at you know, 5 or 6 times cash flow. The odds are good that you'll get a double out of it.

But if you get a business that has stability of cash flows. But the odds are high that they might grow up at some, you know, a small rate let's say 5 to 10% a year then that's what quite a bit more, you know, that will be at least 15 times in my book.

And sometimes you get to businesses, you know, one of the stocks in my portfolio right now. It's a company called Horsehead, you know, the ticker symbol is ZINCQ. You know, I'm not saying this to talk about the business, but they have kind of two facets to their cash flows.

One facet of that cash flows is somewhat independent on the price of zinc. So if zinc prices stay where they are today, which is pretty low right now. You know, these guys may produce somewhere between 130 to 170 million in cash for you from that business if zinc prices stay where they are.

And that might start coming up in a year or 12 that a traditional investment of theirs are finishing off. And so it's a company that has a market cap of 700 million.

And so you know, on the low-end if you look at their – you know, low hundreds type of cash flow let's say 120 million or something 130 million it's like 6 times cash flow company. But you know, zinc prices could collapse like they did which case cash flow would go down.

But also the flip side is that for every $0.10 increase in the price per pound of zinc, their cash flow increase by 25 million. So they're very highly level to the price of zinc. So zinc is for example currently in about $0.85 a pound and the historic range of the last few years, the historic range of zinc is like $0.50 to $2 for example.

And $0.50 is the price when the world shuts down kinda like financial crisis, when no one is using anything so that's kinda unlikely and I think it's unlikely to go below where it is right now.

But it's not outside the realm that in the next few years, zinc prices might be $1.30 or $1.50 or even $2, that it could happened. And so you have this kind of low-end, you can say a 120-130 million of cash flow and extreme high-end you have a 280 million of cash flow right?

So what's the business like that worth. Well you know, I don't know what it's worth but I think it's worth more than where it is sitting at right now.

And so you would – you know, you would look at those sort of [Inaudible] in effect what a business-like ZINCQ is giving you, it's giving you a free option. You know, I'm not paying for those zinc prices going to $1.50 or $1.30 or whatever. If that were to happen almost for sure that stock would move in a very significant way.

And so, you know, I like free options where you have upside without downside. So I think it depends I think when you're looking at these cash flows and such. You know, how stable are they? How variable are they?

And in fact in businesses, which have high variable of new cash flows, you can get wider gyrations from intrinsic value which creates the opportunity to do something about it.



[YAPSS Takeaway]

1. For company with zero to little growth, look into the stability of cash flows.

2. Always buy with the margin of safety.