Investors Should Be Thrilled When Market Slumps, Says Mohnish Pabrai
How should investors react if a stock market slumps 20 percent? According to investor Mohnish Pabrai, gleefully.
Investors should be thrilled when markets drop as it provides “decades of stock buying” opportunities, the portfolio manager said, adding that market direction should not be a factor while investing. He cited examples of cycles in some of the major markets like the U.S. and Korea where the returns have been almost flat over long periods of time, despite the growth in the underlying economy or company earnings.
Pabrai, speaking in a special BQConversations show, said it is hard to predict what stock prices will do and so investors should first make sure that the business they’re interested in buying is within their circle of confidence.
India is at the stage where predicting the index movement might be challenging, and how investors would be better placed doing bottom up research and investing in good growth stories, according to him. “If we understand the business, then we understand it’s worth and once we understand it’s worth, we want to buy it at a significant discount.”
Watch the full interview here
Here are the edited excerpts from the conversation.
How are you feeling about the investing climate? Is it more of what it has always been? Or is 2018 different because of the volatility that we witnessed? There have been various statistics on how December has been the worst month and yesterday we had the strongest bounce...
In general, investors should be thrilled when markets drop. It’s always a good thing when markets drop and it’s negative when they go up. Most of your viewers have decades of stock buying ahead of them. If we have net buyers of equity, we want lower prices. My vantage point, if you tell me markets are down 20 percent, I would prefer that to up 20 percent. It is more interesting to look at things today than what things were three or six months ago. So, that’s great.
Do you worry a lot when people talk about how there could be more Fed (U.S. Federal Reserve) rate hikes or less, the impact that you would have on the U.S. markets because of slowing global economy and wanting to get into emerging markets?
These are all meaningless information. We need to focus on individual businesses. We need to understand what those businesses are going to do over the next five or 10 years. As long as we understand them and they’re undervalued, we like their prospects and we invest in them. The rest of it is not that relevant. In this business, micro trumps macro. So it is a bad idea to overdose on the headlines.
The headlines are there to hopefully provide us better pricing to buy and that is their only use. Beyond that, you must focus on individual businesses and make decisions based on individual business and not where the markets are or where you think the markets are going. In any case, any of those things are hard to figure out.
True. I would want you to use some cycle and some examples out there to explain that, but just one follow up: While the micro might trump macro and when headlines which are scary, it would make the micro more attractive, right? When you are making those large purchase decisions, you probably also have an eye on whether the sentiment on the market is bad so that it could bring the prices a lot more favourable than what they are right now, or do you don’t look at that?
I think its very hard to predict what stock prices are going to do. I think what we want to do is first make sure that the business that we are interested in buying within our circle of confidence and that is one of the most important things. If we understand the business, then we understand it’s worth and once we understand it’s worth, we want to buy it at a significant discount. Now, everything I buy goes down in prices when I buy, everything I sell goes up in when I sell, it just happens to me, no one else.
So I am ever going to be able to pick up the bottom tech and I am never going to be able to sell as the wave is cresting. Neither of those things happen to me. However, even if you are sloppy on the buying and sloppy on the selling, this is an incredible industry with auction during markets spurring up to such a range of prices that one can do really well.
We have some charts here and we would like you to come and explain how you look at past cycles to try to figure out what the markets could do. Also, what an investor should do in scenarios like these because each of the scenarios could be identical or could be completely different from what they are right now.
One of the books that I really enjoyed over the years is a book by Maggie Mahar—‘Bull’. Warren Buffet had recommended it and it’s a great read. Maggie pointed out that the notion of being a long-term investor and doing very well in equity markets by being a long-term investor is not the full truth. The full truth is that equity markets go through very long periods of basically no returns, coupled with also very long periods of extremely high returns.
When you blend it all, over the last 100 years, it was 9 percent every decade in the U.S. There were many decades when there were zero and there were many decades with 19-20 percent. For example, if we look at a 100-year chart of Dow Jones, in 1929, just before the crash, the wave had crested in extreme euphoria. The next time we got back to this level was 25 years later, in the 1950s. So from 1930 to 1955, which is 25 years, we got zero returns. Then we had a 11-year period which was more normal with about a 9 percent return. If you see between 1965 and 1982, which is a 17-year period, we have a huge flat line.
If you look at the S&P 500 chart, it did not give any returns for 25 years until 1950 and during the nine-year period during 1970 till early 1980s. If you again see in 2000, the index was almost flat till 2013 or 2014.
If you look at NASDAQ, which has tech heavyweights, it returned about 20 percent a year between 1980 and 2000. Later the index was flat for 16 years.
Now if we look at Sensex, we started at 100 in the late 70s the index has returned 360 times. There was no stock picking and there were dividends. Sensex, which witnessed a rally until 1992, remained flat for the next 12 years. Later, it witnessed a huge rally of about 51 percent in the next three years. The index was further flat for the next six years and then it returned 10 percent since then.
If you look at the Sensex, I don't use these charts to invest, except once in a while, the charts tell us something. The critical point when they become useful when we get to point maximum pessimism, and today if I look at the Sensex, we're not at the point of maximum pessimism. We're also not at the point of maximum optimism. We're somewhere in the middle of one of these periods, which means that in India, valuations and quality matters.
What I try to look for is do we have tailwind in terms of growth and can we get a price that gives me some marginal safety.
Sensex, which increasingly looks like a growth market with a lot of headlines about how India might be the fastest growing economy in the world and therefore people will start believing that GDP growth will necessarily move on to be equated with market growth. Do you think that’s necessarily the case?
If we look at the U.S. market from 1965 to 1982 it rose a lot before it flatlined. There is not that much correlation between the growth of an economy and growth of the stock market. One would think that the two are correlated. The reason they don’t is that markets tend to get ahead of themselves and so a lot of it gets baked in, we get to these euphoric prices, maximum optimism prices.
In 2000, with the NASDAQ, people thought the whole world is going to change. We had crazy manias going on and it took a long time to work through that so from 2000 to 2018, the U.S. markets have grown a lot but the NASDAQ went nowhere and that is a tech index. It has got all the good stuff in there.
Therefore, we cannot say that the Indian market has a lot of growth ahead of it or the Indian companies have a lot of growth ahead of them and therefore investors will do well. Those two statements don't necessarily go together. The companies will do well. But it matters what the starting point of our evaluation.
In 2000, when Jack Welch left General Electric. GE was the poster child of a phenomenal blue-chip company and there was a lot baked in to what was going to happen to GE. They lost their way and it was a terrible ride for the investors. Part of the reason for the terrible ride was that people bought in at 40 times earnings. The business may still do okay but the returns would not be that great. If one look at CocaCola from 2000 to 2018, it's delivered two-and-a-half percent a year, including dividend to investors. The company’s business has done beyond that. But when you're at 40 times earnings and now you are at 14 times earnings, that's what happens.
And these happen in economies as well, right? for example, you were talking about KOSPI.
I think KOSPI is an interesting one. The Korean market to me is one of the most interesting because Korea has been a great economy. It has been on fire and we have some world-class businesses and has very good cooperative governance.
But if you look at Korea between the late 1980s till 2009, the KOSPI index was flat. During this period, the economy did really well. During this period, we witnessed emergence of Hyundai, Samsung and the emergence of the whole Korean peninsula. The index has remained flat from about 2010 till date. From the late 80s till today, this tiger economy did so well.
The reason why Korea is so interesting to me is that I think Korea at present sits where the U.S. market where positioned in 1982. We are at this point, right here, probably point of maximum pessimism. It is the most exciting markets for me.
Is not India that exciting right now?
India is exciting. But we have to pick through a lot of stuff. In Korea, you can throw darts.
Is not India a throw-a-dart-and-you-will-win kind of a market?
I am not throwing darts in Korea. But If you have bought the KOSPI basket, you would probably do pretty well.
If we see Nikkei Index, it is an example of extreme exuberance coupled with extreme pain. The index peaked during the 1990s the time when companies like Honda, Toyota and Sony were going to rule the world. The Imperial Palace in Tokyo is more valuable than the entire state of California. You can buy the Imperial Palace or you could buy the whole state of California.
When you get to these sets of euphoric periods, from 1990 all the way to 2018, we are now talking about 28 years, we are at 50 percent of the level from 28 years ago. We have not come back. The hangover continues.
The Japanese market, like the Korean market, is very cheap. But they have a little bit difference—the demographics, the population declining, the company should hold a lot of cash, so you have no returns on equity. I am not interested or excited about Japan the way I am more interested about Korea.
For a lot of growth markets such as India, people have not given up on estimates or on growth. We are expensive. In such a scenario, does one go and pick companies very carefully with downsides protected or would you go out and pay a premium for growth?
This is where the PE of one time come in. It is always good to buy stocks one-time PE. One needs to look at the hidden stocks with PE of one time. If you do a Bloomberg screen, you are not going to find it in India, I don’t think you can find them. But if you do, you don’t want to touch them.
Let me give an example: Even in a not-so cheap market which is where India is today, The real-estate sector disseminated after demonetisation. We had listed companies in the real estate sector where I could look at very quick evaluations of their hard assets, finished inventory, nearly finished inventory, discounted, they were trading below liquidation value. If I looked at their earnings edge earned, probably by 2022 or 2023, they would be earning what the market capitalisation was in early 2017.
If I can buy a business for $90 million market capitalisation in 2017 and they are going to make $90 million a year in U.S. dollars in 2023 or 2024, I would love to do that all day long.
I think India is one of the great stock-picking markets of the world because Indian promoters do a terrible job of explaining the business. There is a lot of misunderstanding and distorted views on different business. If you can peel the onion and really understand the business, there is plenty of value to be found in India.
You seem to be bullish on specific pockets of India. But you have sold a lot in in India lately.
Investors buy stocks for only one reason. But they sell stocks for multiple reasons. In the U.S. we have very high tax rates, very normal for funds to do tax-loss harvesting towards the end of the year, a fund could have redemptions, a fund might have something that has dropped value but found something cheaper.
I don’t want to comment on what we are selling and what we are buying, and so on. But I would just say that a buy signal is a real signal, a sell, not for me but any manager, really cannot read too much into it till you know more. So don’t overdose on the sells, overdose on the buys and then do a lot of research.
You are not bearish on India markets at present. You still have some expense in India.
I don’t have views on markets. I have views on individual businesses.
The individual businesses would do well if the markets are thriving.
Not really, if we go back and look at Maruti, HDFC and Asian Paints, they have done well because the businesses have done well. It is always about the business. Even in all these different scenarios where you see these long flat line periods. If you overlay a Starbucks stock chart on that, it will not follow the index.
The game is about individual businesses, it is not so much about market movements. So I actually have no great insight into what the Sensex and Nifty is going to do and I don’t care. I only care to the extent it gives me buying opportunities. The lower it goes, the happier I am. But my focus is on individual businesses and trying to understand where they are going, what they are worth, and can we buy them well below that.
In our previous conversations, there were themes and individual businesses that you invested. Are there themes that are looking interesting right now, either from a value front or from a growth front, otherwise, or you’re not looking at themes right now?
I still think that real estate is a very interesting sector in India and one the big reasons its interesting is because about 90 percent of the real estate companies that participated in metro markets are either gone or are on life support, the unorganised guys are definitely gone. To the people left standing go the spoils, and so the listed real estate companies, the ones that have always conducted themselves, all white money, and so on. The games come to them, and they are being offered with all kinds of deals with “take my land you don’t need to pay me for it I’ll do a JDA, etc.” Those are infinite ROE propositions, phenomenal from the developer’s perspective. I think real estate continues to be a great sector. There are obviously differences between different businesses, but it’s a good place to go fishing.
You have looked at real estate businesses. I remember the last time you came here you said that Indian real estate will go through a metamorphosis of sorts that some of the global businesses have gone through. Do you believe that there is ample opportunity for Indian real estate companies to be multi-billion-dollar businesses? Because currently some of the larger ones would be a couple of billion dollars, maybe slightly over that. Is there scope for such things to happen?
Absolutely. I think the execution matters, hunger by the promoter matters if they say, “I am a billionaire, I’ll hang up my boots, you’re not going to get there.” But I think even when you look at these north of a billion market caps in the real estate praise and you look at their liquidation values. They are still trading well below liquidation value. In these businesses there are two components to the valuation. One is just what you can liquidate for them, which will give you one base level. The second thing, which is also important is what is their earnings engine. Today, their earnings engines are being valued in a negative number. I don’t think they will have a subtraction of value from those earning engines given all the tale of RERA and the competitors going away and so on.
From my advantage point, I think that if you are in bed with a very high-quality promoter group who is hungry and going for what it can execute, absolutely the world is an oyster.
The importance of having a framework and trying not to deviate too much from it because different people buy stocks for different reasons, some people pay a premium but they think that a Rs 10 will become Rs 100, some people like to buy Rs 10 for Rs 2 and none of them is right or wrong. But the importance of a framework and how you follow the discipline to reap rewards for you?
I think I have original ideas, the ideas come from Warren and Charlie, and Ben Gran. I would just say that we are always better off buying, growing pies, and many times it makes sense to pay up for a growing pie. Something is worth $10 and is not going to grow and I can pick it up for $5 or $6. It will do pretty well. But something is worth $10 today and going to be worth $30 in the future, it is probably worth even paying $12 for that or $14 because it makes it even better.
But it goes against the point that you made about trying to buy the one-time PE stocks.
So the one-time PE is, unfortunately, an infrequent phenomenon. I would like to have my entire portfolio in one time PE. The problem is if I go back 19 years and I will go back and look at all the PE of ones that showed up, I think we have had probably six or seven of them show up over a 19-year period, ones every two-three years. At least for the pry funds, we can put maximum 10 percent into one of these ideas, so I would need 10 PE of one time.
So far, the gods have not smiled that well at me. I always love to have PE of one time, in fact, today, at the Pabrai funds in the portfolio, we have more PE of one time than we have ever had in our history. For example, I bought a Fiat Prysmian in 2012, we still own It in 2018. Rain industries, 2015, we still own it. The real estate place, we still own it. Some yet to name ones have shown up recently. Life is great!