Today we’re going to answer one of the all time most common questions:
What’s the best way to discover a potentially great investment opportunity?
This is often a very difficult question to answer (especially with the lofty valuations most businesses are selling for today). Fear not my friend, for there is one tried and true method that always produces excellent investment ideas, and it’s a pretty simple one.
It’s called the Shameless Method.
What the heck is that you ask? Well, you simply need to uncover what the world’s greatest investors are buying and do what they do.
In other words, the best way to find great investment opportunities is by shamelessly copying the world's best investors!
This is always my first step (of seven) when I’m thinking about making any investment. It may be shameless, but it’s also the best start to our investing process; it not only generates great ideas on which companies to buy, but can also give us an idea for what price we should pay to buy them.
That’s why it always finds its place at the beginning of my investing journey. Today is no different. Today we shamelessly look at one of the best investors out there; Mohnish Pabrai.
In this step we must answer three questions:
What Company did Pabrai Purchase?
What price he did he Pay?
Why did Mohnish buy this business?
Next Level Sidenote (NLSn): Our objective, whenever looking at new investment ideas or opportunities is a bit different than you might think. In fact, it’s altogether counterintuitive…Why? Because we’re not trying to figure out how to say yes to an investment thesis. No my friend. What we’re really doing is trying to say No! As quickly as possible.
There are literally thousands of investment opportunities out there, and we don’t want to waste our time on something we don’t completely understand. So instead we say ‘no’, and move onto something we can better understand; something that makes sense to us, is in our wheelhouse, and is deeply on sale. Always keep that in mind as you continue your investing journey. Just because I, or anyone else for that matter, invests in a business it doesn’t mean you should too. Simple as that.
Two ‘Whats’ and a ‘Why’
One of the best methods for not only discovering new stock ideas, but to find the companies that are already undervalued, is to look to the best investors in the industry;
The true Next Level Investing guru’s (NLIG’s for short).
I have a small list of these investors, who I know follow the same investing philosophies as I do. The best part is, we can discover what businesses they own through their (mandatory) 13F filings.
These 13F documents are the holy grail for small investors like us as aspiring Next Levelers, because they tell us what the NLIG’s have bought and/or sold over the last 3 months, and what price they paid.
What did Mohnish Pabrai Buy?
I recently discovered that my favourite NLIG; Mohnish Pabrai, has purchased a large amount of a new Business;
GrafTech International Ltd (ticker symbol: EAF).
Pabrai’s investment philosophy revolves around what he calls the ‘No Brainers’. He looks for investments that are, or soon will be, a ‘PE of 1’ Business. Pabrai believes that as long as nothing is fundamentally wrong with the business, than buying a’ PE of 1’ company makes it very difficult to lose money.
Makes sense right? This means that you’re essentially buying a business that pays for itself after 1 year of earnings. In other words, if we owned the entire business (based on the market cap), then our sunken cost in purchasing the business would be paid off in 1 year.
After that first year, all the cash the business is able to generate would go straight into our open (and eager) pockets. Sweet.
NLSn: As an aspiring NLI, we need to see any purchase of stock as a purchase of ownership of that company. If you own as little as one share of a business, you are now an owner of that business and you need to see it as such.
We need to look at the business as if all the cash, assets, and employees are working for us. It also means that any debts, obligations, and liabilities are also ours.
It’s one of the main reasons why we must be extremely picky when it comes to what we own. It also sets us apart from the vast majority of ‘investors’ out there. Many of which won’t get any further than the ticker symbol and the stock price.
To do better than the majority, you have to think and act differently. We Zag when everyone else is out there happily zigging away.
I know for a fact that Mohnish Pabrai thinks this way. Which to me, also means that he likely sees his new purchase of GrafTech (EAF) as a great investment, and also a potentially great business.
This hints that GrafTech may in fact be a ‘PE of 1’ business. We’ll have to dig into the company to find out if this turns out to be true.
What did Pabrai Pay to Buy GrafTech International?
Next we need to find out WHAT pabrai paid to buy into this business. This is truly an amazing thing… We literally get to find out the price one of the best investors in the world paid to buy what they believe to be a great investment.
I like to imagine that My phone rings, and when I look at the caller ID it says ‘Mohnish Pabrai”. My eyebrows fly up and I quickly pick-up…
‘Uh, Hello?’ “Hey Ryan, It’s Mohnish Pabrai.’ Oh, Hi! What... Why… “I just was calling to let you know that I think I’ve found a great potential investment’. It may in fact be one of my classic PE of 1 Investments, you know, a total No Brainer. Are you Interested?” What? Yes!
“OK Great, the company is called GrafTech International”. I just bought a butload of shares at very close to today’s price and I just thought I’d let you know.” Ok, wow, I don’t know what to say! Thank you Mr. Pabrai, I’ll look into it. “Glad to hear that, I’ll call again in 3 months and update you again.”
I pick my jaw up off the floor... sprint to my computer, and get started on my analysis.
This (almost) literally happens for us every three months, we just need to know where to look. It’s awesome because we can use this information in a variety of ways.
I use this information as a baseline for what a NLIG thinks the ‘on sale’ price of the business is. How does that work? Well, we know that these investors don’t ever pay full price to get into any investment; they are Value/Next Level Investors, which means they demand a large Margin for error.
They demand this buffer in case their original thesis/narrative about the company turns out to be incorrect. This margin for Error allows them to ‘not lose much’ if they turn out to be wrong. Sometimes they will buy it for so cheap that they will still make money, even though their thesis was incorrect.
NLSn: We (as aspiring NLI) set the same rules. We never pay full price for any business, and we demand a large Margin for Error on all the businesses we buy. Why? Because we are not geniuses, and we’re going to make mistakes.
Buying only when a business is deeply discounted gives us the exact investing asymmetry that we’re looking for; High upside potential, low downside risk. That way, even if our thesis turns out to be wrong, we’re much less likely to lose money, or if we do, it likely won’t be nearly as much.
I found out through my research that Pabrai paid an estimated $11.50 a share to own his position in GrafTech. This tells me is that he believes the on sale price for EAF is at or below $11.50 a share. Cool.
It may also say that at this price, the company will be a Mohnish Pabrai Classic; ‘PE of 1’ business. Next. we can quickly check to see what price EAF is currently being offered at, and see how close we can be to buying at the same price as Pabrai. If it’s close, then I get excited! Err, let’s say I get Motivated instead...
Now that I know exactly WHAT Pabrai bought and WHAT price he likely paid, I have one more question to answer, and it’s going to take some digging…
I need to try and understand and discover WHY he bought it. In this case, why did Mohnish buy EAF? And Why does he believe $11.50 is the right price to pay?
Why did Pabrai Buy GrafTech?
I follow Mohnish Pabrai pretty closely, so I know to check his blog “Chai with Pabrai” where he’s quick to post all of his recent interviews.
Using this method I found that he recently had an interview with MOI Global (Manual of Ideas). When you get a hot minute, give it a listen, It’s full of investing wisdom.
However, if you only have a couple minutes, scroll to the end of the interview where you’ll hear him discuss a recent position he has been piling into. He doesn’t mention the company by name, (as he was still trying to buy more of it at the time) but he seems pretty excited about its prospects.
The Why for Pabria
Mohnish is always extremely generous with us. He is constantly sharing his wisdom and investing philosophies, but this time I'd say we are especially lucky…
Normally, we’d have a lot more digging to do before we could uncover what Narrative Pabrai is using as his reason for investing, today however, he seems to have served it up on a silver platter. All I can say is thank you Mohnish!
Here’s what he says in the interview:
Pabrai: “I don’t know whether I should mention this, but I’ll go out on a limb: one of the businesses that I think we’re almost at the tail end of buying, is a company which in the next five years will generate cash flows equal to, or probably higher than its market cap.”
You can see why I’m doing my best to channel my excitement into research motivation, right!? Mohnish calls these type of investments ‘Free Lunches’ because you’re essentially getting something without having to pay for it.
Remember, we see any investment as actual ownership, therefore, If we’re able to buy something that will pay our investment back in five years, we end up with a free lottery ticket with all our risk off the table.
Right now all I can assume is that if I buy in at or below Mohnish’s buy price of $11.50, cash flow alone over the next five years will meet or exceed the current market cap. Sweet!
I Don’t want get too excited though... It’s the rational investors that do well over long periods of time. We can’t just go out and buy something because another investor bought in. We have our own homework to do, and this was just the start. But I’d say we’re off to a pretty great start.
Your first bit of homework is to listen to that interview. I purposefully left out some important information that Pabrai revealed. It’s too important for you to be able to discover them on your own…
In Part Two: Analyzing Graftech we’ll really dig into the company. We’ll find out exactly what it is GrafTech does, and more importantly, how well they do it.
Get excited because this is the interesting part. We get to find out exactly how a business operates. This is the bread and butter of a Next Level Investor. The best part is that even if we don’t end up investing in this business, it gives us knowledge of an industry that maybe we’ve never understood before.
In other words, regardless of the outcome, this process causes growth. The more we do it, the better we become, and that is absolutely in line with becoming a truly great investor.
Until next time.
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