In Mohnish Pabrai’s new book, "The Dhando Investor," the investment manager readily admits that he's pinched many ideas from leading investors. His main message is to copy proven methods and not attempt to innovate on your own dime because the risk is less. Pabrai runs a self named California fund called Pabrai funds that manages millions of dollars for high net worth (HNW) individuals. Pabrai’s fund is modeled after Warren Buffett’s Berkshire Hathaway and value invests in under appreciated companies. His returns are an impressive annualized 28% and what we call smart money.
When we talk smart money we mean money investing like the proven professionals we discuss below. For purposes of this article we compare how smart money invests versus how dumb money invests.
Smart Money
Warren Buffett’s criteria for investing or buying a business:
(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units)
(2) Demonstrated consistent earning power (proforma or future projections are of no interest to us, nor are “turnaround” situations)
(3) Businesses earning good returns on equity while employing little or no debt
(4) Management in place (we don’t want to supply it)
(5) Simple businesses (if there’s lots of technology, we won’t understand it and therefore won’t invest)
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
Rakesh Jhunjhunwala
India’s most renowned investor, Rakesh Jhunjhunwala has made large returns by correctly predicting the India markets more often than his peers. Jhunjhunwala who started with capital of Rs 5,000 then invested it to a net worth of a few thousand crore rupees (US $240,000,000) is a well documented success. If asked, he is quick to point out that he is bullish first and foremost on India's growth story.
Rakesh Jhunjhunwala investment criteria:
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Investment is not number crunching (it’s not only about the numbers it’s a variety of factors including economic conditions).
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The markets teach you to be down to earth (learn from your mistakes and try not to make them again).
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Investment requires all senses and Common sense (investors must learn to recognize political, psychological and economic change and make common sense decisions based on that information).
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Invest in good scalable businesses / companies (invest in companies with large growth potential)
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Leverage to the hilt when tailwinds are favorable (a rising tide floats all boats)
Rakesh Jhunjhunwala’s latest report can be found here.
Peter Lynch
“No modern-day investment "sage" is better known than Peter Lynch. Not only has his investment approach successfully passed the real-world performance test, but he strongly believes that individual investors have a distinct advantage over Wall Street and large money managers when using his approach. Individual investors, he feels, have more flexibility in following this basic approach because they are unencumbered by bureaucratic rules and short-term performance concerns.” - Maria Crawford Scott
Peter Lynch investment philosophy for selecting a company
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Invest in What You Know (The return expectations are derived from the company’s "story")
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Bottom-up approach (prospective stocks must be picked one-by-one and then thoroughly investigated)
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Examine the company’s plans (how does it intend to increase its earnings, and how are those intentions actually being fulfilled)
Peter Lynch on companies to avoid
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Hot stocks in hot industries.
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Companies (particularly small firms) with big plans that have not yet been proven.
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Profitable companies engaged in diversifying acquisitions. Lynch terms these "diworseifications."
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Companies in which one customer accounts for 25% to 50% of their sales.
Dumb MoneyA
OL buys Time Warner Feb 11, 2000
When AOL took over Time Warner ... people said, “Why is this great new media company bothering with this dinosaur”. A couple of years later it's; “Why is this great media company screwing around with this new media company.”
"I don't think they did anything improper," said Paul Kim (Kaufman Brothers analyst), who characterized the company's (AOL’s) financial reporting as "aggressive accounting."
OUTCOME: After the merger, the profitability of the ISP division (America Online) decreased. Meanwhile, the market valuation of similar independent internet companies drastically fell. As a result, the value of the America Online division dropped significantly. This forced a goodwill write down, causing AOL Time Warner to report a loss of $99 billion in 2002 - at the time, the largest loss ever reported by a company.
Daimler Buys Chrysler
Daimler Benz pays $46 billion for the Chrysler in 1998. The vision was to build a broader line of autos sold in the two companies' complementary geographies. The Wall Street Journal has an excellent graphic of the deal relative to its competitors here.
OUTCOME: Chrysler executives quit, combined market value down 50%, or $45 billion. DaimlerChrysler will end up actually paying about $650 million to be rid of the unit.
Hotmail acquired by Microsoft (MSFT) in 1998 for about $400 million
"Hotmail has been a Web mail pioneer," said Laura Jennings, VP of MSN. "Our goal is to combine the benefits of Hotmail with Microsoft services and technology to provide consumers the best combination of free and premium email services."
"We look forward to working with Microsoft on ways we can expand free email services on the Web and bring new features to consumers even more quickly," said Sabeer Bhatia, Hotmail's CEO.
OUTCOME: Hotmail was a second-tier free email service when Microsoft bought it and the acquisition did little to improve Microsoft's internet portal ambitions.
Other Dumb Money Moves
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Not doing your homework. There are thousands of publicly traded companies out there, and it would be folly to try and track them all. Zero in on a handful, no more than a dozen, and learn the nuts and bolts of the company. Warren Buffet likens the process to reviewing the company as if you were to buy it all rather than just a few hundred shares. Only buy something that you're comfortable with.
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Speculating rather than investing. If you're listening to 'hot tips' and buying stock in companies you don't know just because they seem to be on a tear, you're not investing; you're speculating. This is more gambling than anything else, and it works pretty well in good times when the tide lifts all boats. Unfortunately, it's a recipe for disaster when things turn sour, as any day trader learns eventually.
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Hanging on to losers. So you bought a high-flier near the peak only to ride it all the way down into the doldrums. That's not an automatic sale-signal in itself, but if the fundamentals tell you that the company is going to stay down quite a while, you may be better off cutting your losses and at least salvage the tax write-off. Waiting and praying that a tech stock 90% off its peak value will regain its former shine is a waste of time; that money could be better invested in a company with good growth prospects.
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Trusting an unknown stock broker. When some slick broker calls and promises to double your money in 90 days, there is only one response: hang up. Most are perfectly legit professionals. But in order to deliver the fantastic results they talk about, they must take enormous risks - with your money, that is. They get their commissions whether you strike it rich or end up in the poorhouse.
Summary
The smart money asks if the business profitable? Are we paying a reasonable price for the asset? Does it have a sustainable competitive advantage? Is the economy suitable?
The dumb money asks about conceptual information regarding the business without studying the fundamentals. The leaders of these dumb businesses say; “It will allow us to do this and it will allow us to do that, and it will provide a platform for moving into the next era”, etc. They are short on details on the financial side because there is no financial side.
Yet the dumb money crowd still act like expert art purchasers outbidding each other for a white canvas with an unknown painter in hopes he’ll paint a masterpiece.
The smart money moral: In the footprint of an elephant everything fits
The dumb money moral: Don’t invest in art…
Suggested Reading:
11 Disrupting Web 2.0 Internet Companies that will Change India
Note to Mukesh Ambani – Why rich should share wealth with poor
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