Dhandho 201: Invest in Distressed Businesses in Distressed Industries
In this chapter, the author introduces the merits of investing in struggling businesses in struggling industries. While he imagines the market is generally efficient, he believes that investors can carefully find the situations where it is not. When a company or its industry is in trouble, it can often sell at a substantial discount to its intrinsic value due to widespread fear in the marketplace. It is this phenomenon that has created opportunities for investors to buy stocks at deep discounts.
For those who think that the market is always efficient, the author mentioned a few famous quotes by Warren Buffet in his book: "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."
Mohnish Pabrai, discusses several ways for investors to find struggling industries/companies. For one thing, corporate headlines are often filled with negative news and outlooks for specific companies 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 after Elliot Spitzer's investigations.
Another useful place to find trouble is Value Line's weekly report of the stocks that have lost the most value. It also releases a list of the stocks with the lowest P/E and P/B values. Pabrai also recommends reviewing 13-F disclosures to see what other investors are buying and using Value Investors Club. He also suggests that investors read Greenblatt's The Little Book That Beats The Market for assistance in this area.
From the above sources, it is possible to identify many troubled industries and companies. He recommends that investors exclude those businesses which are not simple to understand or fall outside the investor's competence. For the remaining stocks, the Dhandho framework should be pursued to determine which of these stocks should be bought.