In this chapter, Pabrai extolls the virtues of investing in distressed businesses in distressed industries. While he believes the market is mostly efficient, he believes that investors paying close attention can find the situations where it is not. When a business (or its industry) is distressed, it can often sell at large discounts to its intrinsic value due to the fear that is prevalent in the market. It is precisely this phenomenon that offers investors the opportunity to buy stocks at large discounts.
For those who believe the market is always efficient, Pabrai offers the following Warren Buffet quotes:
"I'd be a bum on the street with a tin cup if the markets were always efficient"
"Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn't do any good to look at the cards."
"It has been helpful to me to have tens of thousands [of students] turned out of business schools taught that it didn't do any good to think."
Pabrai discusses several ways for investors to find distressed industries/businesses. For one thing, business headlines are often filled with negative news and outlooks for particular businesses and industries. Examples include Tyco's stock during the Kozlowski scandal, Martha Stewart's stock following her prison sentence, and H&R Block's stock following Elliot Spitzer's investigations.
Another useful place to find distress is Value Line's weekly summary of the stocks that have lost the most value. It also publishes a list of the stocks with the lowest P/E and P/B values. Pabrai also recommends looking at 13-F disclosures to see what other value investors are buying, and using Value Investor's Club. Pabrai also recommends that investors read Greenblatt's The Little Book That Beats The Market for help in this area.
From the above sources, a plethora of troubled industries and businesses can be identified. From this group, Pabrai recommends investors eliminate those businesses which are not simple to understand or which fall outside the investor's circle of competence. For the remaining stocks, the Dhandho framework (as discussed in the rest of the book) should be followed to determine which of these stocks should be purchased.