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Mohnish Pabrai's 5 Categories Of 10-100 Bagger Stocks

by: Mike Gorlon
Mike Gorlon
Value, growth at reasonable price, long-term horizon, long/short equity

There are 5 categories that Mohnish Pabrai discussed in his lecture to students at the University of Peking that make up 10-100 bagger stocks.

They are: (1.) companies with deep moats, long runways and even stupid managers can run them, (2.) the same as the 1st category, but need smart managers.

(3.) businesses where the market gets confused between risk and uncertainty, (4.) businesses going through bankruptcy, reorganization, public LBO, busted LBO, and special situations.

(5.) companies with upside and no downside.

I just read Mohnish Pabrai's lecture that he gave on October 14, 2016, to some finance students at Peking University. I rank it as one of the best reading materials for aspiring and current investors of all styles. One reason is because Mohnish does what most investors shy away from doing in public lectures: talk openly about their experiences, whether positive or negative. Most investors will talk about their strategy and give some predictions, but very rarely do they delve into their experiences in so much detail.

The main point of Mohnish's lecture is to help these students find the 10-100 baggers in the market. A bagger is simply a multiple of how much the stock price is going to go up. So if a company sells at $10 a share and it's a 10-bagger, that means the company went up 10 times and would now be worth $100 a share.

By giving this lecture, Mohnish is also trying to help himself understand his thought process better to help himself find these 10-100 bagger stocks. What he does is he categorizes these 10-100 baggers into 5 categories that he discovered from his own investing experience. Mohnish admits though that there could be more categories, but he was only able to find five between the time he started preparing his lecture and right before he gave lecture.

The 5 categories are:

(1.) Businesses with huge tail winds, large moats, normally low debt levels and high returns on equity, where even stupid managers can run the companies. Examples that Mohnish gives are Coke (NYSE:KO), See's Candy (BRK.A, BRK.B), MasterCard (NYSE:MA), Visa (NYSE:V) and Moody's (NYSE:MCO). Here is a quote from Mohnish on what he says to do once you find this category of businesses:

"The first thing to do when you run into businesses that idiots are running or can run and they still continue doing business, is buy those companies. If they have these characteristics, then forget the P/E ratio. Just buy and hold forever, because there are very, very few businesses on the planet like this. I can almost bet that 10 or 20 years from now, Maotai looks very different. It's hard to tell the path it takes, but it looks like a great business."

(2.) Businesses with huge tail winds, large moats and high returns on equity, but smart managers need to run these companies. Examples that Mohnish gives are: McDonald's (NYSE:MCD), Costco (NASDAQ:COST), Dominos (NYSE:DPZ), Yum! Brands (NYSE:YUM), Restaurant Brands (NYSE:QSR) (owner of Tim Hortons and Burger King), Geico and Amazon (NASDAQ:AMZN).

(3.) Businesses where the market gets confused between risk and uncertainty. These are businesses that are usually cyclical and are in an industry that are out of favor, but usually have very little debt and the earnings are projected to increase over the next year or two, which would bring the P/E ratio down to a very low ratio like 5. Some good insight that Pabrai talks about is his investment in Fiat (NYSE:FCAU), which is his largest holding in his portfolio at around 26% as of September 30, 2016.

"Fiat Chrysler's very similar to Ipsco [a company Mohnish spoke about earlier in this lecture] - the stock around $6. The management of the company says that in the year 2018, their earnings are going to be around $5. If the management is correct about the future prospects of the business then basically the business has been priced at 1.2 times earnings for one year. My answer to that is, 'Okay, we'll hold the stock to 2018.' They have $130 Billion in sales of cars. They just started manufacturing Jeep [sic] in China. The Chinese love their Jeeps. Raise your hand if you think [the] Chinese love Jeeps. All right, at least a few Chinese love their Jeeps. That's great. Their Jeep sales are going up in 5x in the next three years in China. I happen to think that what they're saying makes sense. The market thinks it doesn't make sense."

(4.) Business going through bankruptcy, reorganizations, public LBOs, busted LBOs and special situations. The example that Mohnish gives here is when Sam Zell worked with Martin Whitman to buy a bankrupt company that had $630 million in net operating losses. Their plan was to buy another company and use the net operating loss to not pay any taxes. That other company they bought was a barge company shipping company on the Mississippi River, and it eventually went bankrupt, giving them $800 million in net operating losses. And although I may be making it sound favorable to keep racking up operating losses to avoid paying taxes, it certainly isn't. As Mohnish says in this lecture, "I don't know whether you teach them, Professor, how to calculate bankruptcy to the power of bankruptcy, but it's not good." Anyway, they had $800 million in net operating losses, and then they bought another company that turned garbage into electricity, and according to Mohnish, it eventually worked out.

This category, in my opinion, is the hardest to find these 10-100 baggers in.

(5.) The last category is upside with no downside. These companies have some exposure to the bubble area of a market. The example that Mohnish gives is Silicon Valley Bank during the dotcom bubble. Silicon Valley Bank had warrants on the internet companies that were in a bubble, and it was theorized by investors that it had some warrants but never told the public market until 1999-2000 - when most of the reward/risk was already priced into the stock - how many warrants it had or what they were worth. The bank was able to get these warrants because it made loans to these dotcom companies. That's how Silicon Valley Bank operates at times - it gives stock options to the gardener, the landscaper, the painter, etc. So in conclusion, Mohnish looked at Silicon Valley Bank and concluded that it was trading at a low valuation so that limited the downside, but there was lots of upside because of these warrants.

Another notable part of his lecture that makes it worth reading is the mental model on how to find 10-100 baggers that his friend Guy Spier uses. What he does is look for the most successful companies that performed in a developed market like the U.S. (Coke, Moody's, etc.) and find the company with the same business model in a less developed country like India. Guy Spier did this - he looked in India for a company that was just like Moody's and found a company called CRISIL. Even more encouraging to Guy was that he noticed that Moody's did the due diligence itself and bought a 10% stake in CRISIL. Guy's investment made him four times his money, but it eventually went up 130 times after he sold it.

Mohnish also talks about what he believes is the number one skill set to have in investing - and that is patience. This is because in order to find the companies in the first category and to fully realize the compounded return of the companies in the first category, you need to refrain from selling too early - even when you are sitting on a big gain - and just let the company continue to compound capital over decades.

I will leave you with what Mohnish tells these students at Peking University is the "key to life," but I think he meant the key to investing:

"The key to life is find CRISIL. That's the Moody's of India, and then just go to sleep for 20 years. That's it. The purpose of this talk is for me to understand that to become even less active is to not even wake up at 9:30 in the morning, but to wake up at 2:00 in the afternoon. Who cares? Because we found CRISIL and then the guys at CRISIL will make all the money for us, so we don't need to do anything."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.