Pabrai

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Today’s post is courtesy of Wealth Building Lessons.

This past year, the stock market has seen incredibly volatile swings. My non-retirement portfolio has been up 20% and then down to 0%. Twice. Of course, my portfolio doesn’t have a direct correlation with any of the indices but it just as vulnerable to the moods of the market.

Most people have a tendency to bail at the bottom of the market and buy at tops. They let their emotions take control of their investment strategies. The main reason for this is their lack of investing intelligence. They either do not have strong fundamental reasons to buy a stock. They usually buy it because its gone up in price and looks like it might go higher. That’s often a poor reason to buy a stock (as a long-term investment strategy. Although for short-term trading it might work).

According to Berkshire Hathaway’s (NYSE:BRK-A) (NYSE:BRK-B) Vice Chairman Charlie Munger:

If you are not investing based on fundamental valuation principles, you are not investing. You may think you are, but Ben Graham had another term for it: speculation.

So what is intelligent investing?

As Benjamin Graham stated in the book Security Analysis: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” Graham’s definition implies that a true investment is made only when you have the right data and reasoning, followed by a suitable price that ensures a margin of safety. Putting capital to work any other way is, by its nature, speculative.

Value investors don’t focus on their performance in a bull market, but on their perseverance during a bear market. In his 1961 partnership letter, Warren Buffett expressed this crucial point when he told his partners, “I would consider a year in which we decline 15% and the [Dow Jones] average 30% to be much superior to a year when both we and the average advanced 20%.” Most investors don’t fully grasp this investing approach, and the result is inferior long-term performance relative to the benchmarks.

Speaking of bear markets, in the 1960s, Warren Buffett invested more than 30% of his assets in one company, American Express (NYSE:AXP), during that company’s worst scandal. While everyone else was bailing, Buffett stood still, because he was confident in his data and reasoning.

Always remember that price is what you pay and value is what you get. According Fool.com, a fantastic business like Google (Nasdaq:GOOG ) is undervalued at one price, fairly valued at another, and overvalued at
yet another. At the current price, investors in Google are sacrificing a margin of safety and betting on the continuance of very high growth rates, which we know simply cannot go on forever. It’s one thing for a company like Google to double profits from $2 billion to $4 billion, but it’s much more difficult to go from $20 billion to $40 billion.

According to silver analyst Jerome Smith, who wrote in his book “Silver Profits in the Seventies”, more than 30 years ago “Truly outstanding investment opportunities occur only occasionally. In general, the better they are, the rarer they are. Such opportunities are normally long-term in their maturation and by careful study can be foreseen long before they come to the attention of most investors. … The very highest profit potentials occur whenever there is a convergence of two or more primary causes.”

Smith was referring to silver, but his words also characterize the qualities of superior investments that true value investors seek to exploit. Smith is right: Really good investment ideas are rare. So when you find one, bet big. If your thorough analysis is correct and the price is right, you should have no hesitation in investing heavily.

Consider Mohnish Pabrai of Pabrai Investment Funds. Pabrai currently manages about $600 million or so, up from $1 million in 1999. About 80% of that total is parked in just eight to 10 of Pabrai’s best investment ideas. The result is a 29% net annualized return since inception, meaning that a $100,000 investment back in 1999 is worth almost $800,000 today.

If your convictions won’t allow you to put 10% of your assets in one investment, you probably don’t need to have even 1% of your assets invested. But that’s why such obvious investments are so rare, and when your data and reasoning are correct, be sure to take advantage of the opportunity.

Buying good businesses at bargain prices allows the investor to ride out a storm relatively unscathed. But sound investing is not easy. The key is to train yourself to be unemotional about the market and maintain an unwavering level of discipline. History has shown that there will always be periods of prosperity followed by periods of economic contraction. That will never change. If you invest with the aim of keeping your capital, the upside will take care of itself.

Monish Pabrai is being called the ‘young Warrent Buffett’. He’s been returning 30% annual returns for his investors, similar to what Warren Buffett had been returning in the initial stages of his career.

He’s come out with a new book:
The Dhandho Investor: The Low – Risk Value Method to High Returns

Based on the fact that his previous book, Mosaic: Perspectives on Investing is now selling for about $495, it might be worth picking up a copy as an investment, even if you don’t like reading!

I happened to meet Mr. Pabrai when he was giving a speech in Orange County a year ago and was lucky to pick up a signed copy of Mosaic. Signed copies of that book have sold for $2,500!!! I hope I didn’t throw it away, it was lying in my car trunk for the longest time.

I haven’t read the new book yet, but its next on my list (after I finish The Black Swan: The Impact of the Highly Improbable which is an awesome book on the philosophy on improbably events affecting investing).