10 stocks generated by this simple Buffett-inspired strategy

by Ben Hobson from Stockopedia |

He’s lunched with Warren Buffett, sold a business for millions and runs his own fund. Now read about this star investor’s 9-point investment plan.

Back in 2007, Mohnish Pabrai and his friend and fellow investor Guy Spier, paid $650,100 in a charity auction to have lunch with the billionaire Warren Buffett. 

Pabrai later said he’d used the lunch to thank Buffett personally for all that he’d learnt from him over many years. He said the three hours that he and Spier had spent with him in a Manhattan steakhouse had been “a terrific bargain”. 

Indeed, the hunt for terrific bargains in many ways encapsulates Pabrai’s investment strategy.

Mohnish Pabrai - a value contrarian

Mohnish Pabrai is a popular figure on the US investing scene. After immigrating to the US from India in the 1980s he studied engineering and later worked in IT. From there he started his own business before selling it in 2000 for a reported $20 million. 

These days he’s better known for running Pabrai Investments Funds, currently with $575 million under management, as well as a zero-fee investment firm called Dhando Funds. He’s also written the books The Dhandho Investor and Mosaic: Perspectives on Investing.

In many ways, the charity lunch with Buffett was the culmination of several years in which Pabrai had honed his own investing framework. Buffett had been a major influence on his thinking, leading him to adopt a contrarian strategy that essentially blends value and quality.

In the Dhando Investor, Pabrai explains that the core of his strategy is “heads I win, tails I don’t lose much”. That means picking investments where there’s a wide margin of safety and the upside overwhelms the downside. More specifically, Pabrai - who often stresses the importance of using investment checklists - sets out a 9-point Dhando framework:

1.    Focus on buying an existing business (rather than backing start-ups or firms with unproven models)

2.    Buy simple businesses in industries with an ultra-slow rate of change (which are often unloved and potentially underpriced by the market)

3.    Buy distressed businesses in distressed industries (where the margin of safety may offer attractive value opportunities)

4.    Buy businesses with a durable competitive advantage (the very profitable moat-like strengths that Buffett is so fond of)

5.    Bet heavily when the odds are overwhelmingly in your favour (be patient and wait for Mr Market to serve up attractive investments)

6.    Focus on arbitrage (special situations where businesses for some reason become super-profitable for short periods of time)

7.    Buy businesses at big discounts to their underlying intrinsic value (in the classic value strategy, the aim is to buy stocks cheaply rather than overpay) 

8.    Look for low-risk, high-uncertainty business (where the downside risk is low but the market underprices them because it doesn’t fully understand the business or its outlook)

9.    It’s better to be a copycat than an innovator (prefer stocks that can execute a proven idea or business model better than others)

The thrust of his strategy is to be patient and wait for value opportunities to be presented by the market, even if they are rare. As a starting point, he says he looks for very low price/earnings (PE) ratios and high yields in what are typically out of favour stocks. When they come along, his focus is to stack the odds of success in his favour by having a wide margin of safety and then betting big.

This week we’ve taken some of those ideas and applied them to the UK market to get a flavour of the types of mid-cap stocks that Pabrai might look for. Apart from the PE and yield, the screen considers how far the share price is from the 52-week low (indicating out of favour stocks). It also uses Stockopedia’s Quality/ Value Rank as a proxy for shares that are both ‘cheap’ and ‘good’ - the higher the ranking out of 100, the better.

Name P/E Ratio Yield % Price vs. 52 Week Low % Quality/ Value Rank Sector
Ferrexpo (LSE:FXPO) 2.6 11.5 21.4 99 Basic Materials
Globaltrans Investment (LSE:GLTR) 4.9 16.6 19.4 99 Industrials
Royal Mail (LSE:RMG) 7.7 8.4 6.1 99 Industrials
Go-Ahead (LSE:GOG) 11.6 5.1 15.8 99 Industrials
Central Asia Metals (LSE:CAML) 8.7 6.7 16.2 97 Basic Materials
Northgate (LSE:NTG) 7.3 6.9 0.9 94 Industrials
Crest Nicholson (LSE:CRST) 11.2 7.5 34 94 Cyclicals
Vesuvius (LSE:VSVS) 10.2 4.6 34.4 93 Industrials
Petrofac (LSE:PFC) 5.5 8.6 1.6 92 Energy
Stagecoach (LSE:SGC) 7.5 5.4 27.2 91 Industrials

Source: Stockopedia

It’s worth remembering that this is a contrarian value strategy that deliberately looks for cheap shares with solid quality financials. It’s in this kind of territory that Pabrai would look for potential investments that pass his Dhando framework. 

On this basis, the strategy picks up ideas in the mining and metals processing sector like Ferrexpo (LSE:FXPO), Central Asia Metals (LSE:CAML) and Vesuvius (LSE:VSVS). Others include the transportation groups Go-Ahead (LSE:GOG) and Stagecoach (LSE:SGC) as well as Royal Mail (LSE:RMG), vehicle hire group Northgate (LSE:NTG), housebuilder Crest Nicholson (LSE:CRST) and oilfield services business Petrofac (LSE:PFC).

A Buffett-inspired approach to value

Like many value investing strategies, Mohnish Pabrai’s Buffett-inspired approach to finding investments relies on going where others fear to tread. In uncertain conditions, where stocks can be marked down sharply, value strategies like this are proven to be very profitable. But more broadly, the attraction of Pabrai’s framework is its simplicity and focus on buying shares where the investor has a circle of competence.

In what’s turning into a lifelong friendship between Pabrai, Buffett and Buffett’s business partner Charlie Munger, there continue to be clear echoes of their influence in Pabrai’s thinking. For value-oriented investors, his framework offers some useful rules for getting started.

Stockopedia helps individual investors beat the stock market by providing stock rankings, screening tools, portfolio analytics and premium editorial. The service takes an evidence-based approach to investing, and uses the principles of factor investing and behavioural finance to help investors make better decisions.

  • Interactive Investor readers can enjoy a two-week free trial and £50 discount to Stockopedia using the coupon code iii014 - click here.

These investment articles are simply for generating ideas. If you are thinking of investing they should only ever be a starting point for your own in-depth research.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

get more news and expert articles direct to your inbox
Sign up for a free research account and get the latest news and discussion, and create your own Virtual Portfolio
sponsored articles from our partners