Mohnish Pabrai: Invest In Businesses With The Most ‘Hair’ On Them

In his book – The Dhandho Investor, Mohnish Pabrai explains why value investing involves investing in businesses negatively perceived by the market, and these businesses often yield the most significant returns.

Fama and French’s research shows that from 1963 to 1990, stocks with the lowest price/book ratios outperformed those with the highest ratios by over 11% annually. Despite the potential for substantial gains, these undervalued stocks are often overlooked by active managers due to their unappealing nature.

Joel Greenblatt’s Magic Formula, which advocates for such investments, tends to outperform active managers with minimal effort. However, its adoption remains limited among investment teams.

Here’s an excerpt from the book:

Value investing is fundamentally contrarian in nature. The best opportunities lie in investing in businesses that have been hit hard by negativity.

Even the pundits of the efficient market theory, Eugene Fama and Ken French, concluded that stocks in the lowest decile of price/book ratios outperformed stocks in the highest decile by over 11 percent a year from 1963 to 1990.

If you had invested $10,000 consistently in stocks with the highest price/book ratios (the Googles of the world) in 1963, it would have grown to about $72,000 by 1990. Not bad. However, if you had invested those same dollars in the cheapest businesses, you’d have $915,000 by 1990. I’d say that’s a statistically significant difference.

The problem is that the businesses in the lowest deciles are ones “with the most hair on them.” Investing in them is clearly the ticket to wealth, but trying to get any type of active investment team to buy bucket loads of these hairy, hated, and unloved businesses just isn’t going to happen.

It is the same reason that Joel Greenblatt’s Magic Formula (highlighted in The Little Book That Beats the Market) is likely to trounce virtually all active managers with very little work.

Nonetheless, most active managers won’t buy meaningful quantities of Magic Formula type stocks. There is the final aspect I cloned.

You can find a copy of the book here:

The Dhandho Investor – Mohnish Pabrai