An Australian investor recently met Mohnish Pabrai and wrote about his experience meeting Mohnish. I love reading these fly on the wall style reports when investors meet Buffett, Munger, and Pabrai in-person.
In that write-up it is reported that Mohnish was asked to talk about one of his more successful investments and Mohnish’s response was all about the downside. Here is what was written in the write-up:
When asked to explain more about one of his more successful investments, his response focused solely on the downside of the investment. His analysis concluded that because he had almost no chance of losing money he thought he had a good chance of making it — and that he did.
Look at that second sentence. Because he had almost no chance of losing money, that is is why he though he had a good chance of making money.
Genius. Brilliant. Life-changing.
I need to focus on the downside more when I invest and this Mohnish story has hammered that home for me. If you have almost no chance of losing money, then you could have a good chance of making money. Focus on the downside first!
So what is the downside? And how can losing money be avoided?
To me, the downside can come from three factors, the business, the valuation, and the debt.
If the business is in decline, or if there’s a chance the business will decline, then this can be ruinous. If trends or competitors can shrink a company’s earnings, and the valuation goes down, you will lose a lot of money.
If the valuation is too high when you make the investment, and it goes down, you will lose a lot of money!
If there is too much debt, and the company can’t handle it and meet its interest and principal responsibilities, you will lose a lot of money!
Money is made by focusing on the downside.