The Dhandho Investor: Chapter 7

Mohnish Pabrai is an Indian-American businessman and investor. For a number of years, he turned heads with the performance of Pabrai Investment Funds since its inception in 1999. Pabrai has high regards for Warren Buffett and admits that his investment style is copied from Buffett and others. Over the next few weeks, we'll be exploring the topics in his book about value investing.

Now that Pabrai has established that the best place to look for returns is in the stock market, he turns his attention to discussing why investors should restrict their investments to simple and predictable companies.

A stock will sell on the market for a particular value. The investor must compare this selling price to the actual worth of the underlying business. The worth of the underlying business is determined based on the business' future cash inflows and outflows.

To demonstrate this, Pabrai takes the reader through a quick valuation of Bed, Bath and Beyond in 2006. While the stock sells with a market value of about $11 billion, the estimate of the worth of the underlying business conducted by Pabrai reveals the company is probably worth between $8 billion and $20 billion. As such, this investment should not excite the reader much.

By changing the expected estimates of the cash inflows and outflows of a business, however, its valuation can change dramatically. It is for this reason that it is of utmost importance to stick to simple and easy-to-understand businesses. If a business' future can be predicted, an investor can calculate its intrinsic value with more accuracy. In turn, this allows the investor to know that he is buying a company at a discount.