Yes! Another eureka moment!
Whenever I watch a Mohnish Pabrai, Warren Buffett, or Charlie Munger interview or lecture, there’s always a eureka moment where I’m shouting for joy because anther investing lesson has been learned. Sometimes these guys say something with such clarity that it makes me shout for joy. And this weekend while I was walking and taking in Mohnish’s new question and answer session with the London Business School, I had one of these eureka moments.
Something I’ve been struggling with for months now is finding time for extensive stock research, general reading, and running my business. I just haven’t had time for all three. So I’ve focused on running my business of course, as that’s the golden goose that lays the eggs, and I’ve also spent a lot of fruitless time hunting for no-brainer stock investments. But my general reading time has fallen off, and that’s upset me, as I really want to do a ton of general reading everyday.
My eureka moment came during this video when I heard Mohnish talk about how he sifts through stock ideas and how his objective is to reject stock ideas as quickly as possible. I have the embedded video below set to this specific question around the 16 minute mark. Let’s take in Mohnish’s discussion of rejecting stock ideas and then we’ll continue this article.
Mohnish says that his objective is to as quickly as possible reject the idea so he can get back to general reading. He says that the model is not to find investments, rather, the model is to find the flimsiest reason to say “no.” And as soon as you get to the first reason to say no, you move on.
And he says that there are two things that help you get rid of stock ideas very quickly, circle of competence and valuation.
Mohnish says that this two item checklist takes as little as 60 seconds.
First, determine whether or not the business is within your circle of competence. Over the last year, flipping through Value Line, I’ve probably wasted one to two hours of my life looking at pharmaceutical companies’ cash levels, wondering if they were selling for less than net cash. But you know what’s so stupid about that, pharmaceuticals are not in my circle of competence, and even if I found a company that was selling for $100 million and had $200 million of net cash, I still wouldn’t invest in it because pharmaceuticals are not in my circle of competence and I wouldn’t know why they had that much cash, or how long they were planning to use to is get through annual losses, or if I’d ever even be able to get my hands on that cash. What a horrible waste of time! If its not in your circle of competence, move on! This process should take 15 seconds.
Next up, look at the valuation and if its not at a PE of 1, move on. Simple as that. Like Mohnish, I am only looking for multi-baggers than come from PE of 1 situations. If a company is selling for $100 a share and the intrinsic value is $130 a share, I don’t care! I don’t want to waste my time or life worrying if Mr. Market is off by 30% or 50%. I want to do deals with Mr. Market when he is off by factors of 5, 10, and 100. I’m not here to spend my time looking for gains of 30% or 50%. I’m looking for multi-baggers that will bring me 5 to 1 returns. And these multi-bagger come from PE of 1 situations. And the only other thing I’m looking for are 100 baggers, and I’ll be able to find those by looking at top line and/or bottom line growth.
The thing is, PE of 1 situations will hardly ever be able to be seen by just looking at the PE level and finding a number of 1. Usually they’re hidden. Like how Fiat Chrysler is currently a PE of 4 to 5 and management thinks they can grow earnings to around $8.50 a share within a few years and at that time the stock will be selling for less than a PE of 2, if it’s at the current price level. So it’s not as straightforward as seeing an exact PE of 1, but I get what Mohnish means by that kind of thinking and qualifying.
As a hypothetical, if I’m scanning The Wall Street Journal’s 52 week highs and lows and see that a great company like Coca-Cola is selling for a 52 week low, I’d be inclined to check it out. But then what would I see? That it’s selling for a PE of 24? Maybe its intrinsic value is to sell at a PE of 28, and that’d be fine, but I’m not interested in 16% gains. I’m interested in multi-baggers and 100 baggers.
The 100 baggers are a special case. They come from growth. Growth in sales, growth in earnings, and growth in valuations. They’re rare and a whole other conversation. The way I’ll quickly filter for those is by scanning top lines and bottom lines for growth. If I don’t see a ton of growth, move on, there’s no 100 bagger possibility.
But more day to day, in terms of searching for the multi-baggers that come from PE of 1 stocks, here’s how I’ll filter for those.
First, in the first 15 seconds we filter for circle of competence. If it’s not in our circle of competence, move on, if it is, then take another 45 seconds to look at the valuation. Rarely will it ever say “PE of 1.” As the PE of 1 is usually hidden. But it might have a PE of 2, 4, 8, or maybe even 10. But rarely will a PE of 20 to 30 ever turn out to be a hidden PE of 1. So once a stock idea gets past my 15 second circle of competence check, then I’m taking 45 seconds to look at the market value and the earnings and sales over the last few years. And if it doesn’t look like there’s any possibility that there’s a chance it could be a PE of 1 situation, I’m moving on. And fast.
With this 1 minute, two-item stock-screening checklist, I’ll be able to fly through investment ideas, reject them as quickly as possible, and get back to my general reading. If I allocate two hours a week to screening for stock ideas, I’ll be able to get through 120 stock ideas a week and 480 a month. The good news is there’s only a few thousands public companies in the US and as Mohnish says, we’re only trying to find 2 or 3 good ideas each year.
And if a stock idea is in my circle of competence and seems to have a valuation that could make a PE of 1 a possibility, then I’ll allocate another 5 minutes to the idea, looking for a way to reject it, and if I can’t reject it in 5 minutes, then I’ll give it 15 minutes to see if it could be one of my 2 or 3 good ideas for the year.
I made the following three slides to help remind me that the idea is not to find stock ideas, the idea is to reject them, to remember the two-item stock idea checklist, and that we’re only looking for 2 or 3 stock ideas per year.