One way to find investment opportunities is to find what Mohnish Pabrai calls “Hidden PE of 1s”.
You can learn more here: https://www.youtube.com/watch?v=8KxRViiSORI
Before We Start
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Screening For Low PE
If you setup a screen to see companies with a PE of 40 or less, you’ll have thousands of companies.
The same with a PE of 30 or 20.
Even a PE of 10, you’d have over a thousand.
If you screen lower, like a PE of 5, 3, or 1, you’ll still find some.
These are the non-hidden PE of 1s.
What you want the hidden PE of 1s.
They are a PE of 1 but they don’t show up as such on a screener.
They can be a PE of 1 based on future earnings.
Fiat Chrysler Example
2012 he invested in Fiat Chrysler.
It was trading at under $5/share
The company had forecasted that in a few years, it would be earning $5/share.
The company exceeded the target (if you include the Ferrari earnings and the Fiat Chrysler earnings).
So what they paid in 2012, materialized in 2018.
The end result is that investment went up 7 or 8X in that period.
When you do PE of 1s, in general, good things happen to you.
Ipsco Example
At the time, he invested, in 2004, IPSCO was trading a PE of 3
But 1/3 of the market cap was in cash.
So now, its trading at a PE of 2 (if you adjust for the cash).
The earnings the next 2 years with the company’s own guidance was what the company expected to make in cash flows in the next 2 years.
There was no visibility.
It was possible that in 2 years, earnings would fall off a cliff.
His thinking was, if you held the stock for 2 years, you’d get all your money back. Then at that point, he wanted to see what the stock would trade at.
It had to trade for something because it had all these huge plants and infrastructure and everything else.
The result was that a year after they bought the stock, the company said earnings would continue for 3 years.
Right there, he was in the black.
As they got close to 2 years, someone came and bought the company.
They ended up with a 4X return in under 2 years.
In the last 19 years, its’ happened at least 6 or 7 times that he’s found a PE of 1.
Stewart Services Example
It was a PE of 2 in Value Line
Usually the PE of 1s and 2s in Value Line have problems — you normally want to avoid them
But every once in a while, there is a gem in there that shows up
The reason he was interested when it showed up — is they are in the business of burying dead people.
The funeral services business have the lowest rate of business failure across all the SIC codes (across all industries).
The reason for that is obvious:
-Nobody wants to go into the business
-That means less competition
-People don’t shop for the lowest price
-They have a lot of upsells
-People tend to use the same supplier every time
So that is why it was a protected business.
Takeaways:
Use the screeners to start (he uses Value Line)
Net cash can mean the price is much lower than stated
Future earnings — if trustworthy, can increase the earnings
A lower price, and higher earnings creates a hidden PE of 1.
Turkey has a lot of PE of 1s right now
Mohnish seems to trust future earnings forecasts if it comes from the company management.
Last, sometimes you just get your money back, but at the end of your investment time horizon, you still get a bonus because the net assets have value.
Summary
Say I have a company selling at a market cap of $100M.
But I have $50M in net cash
The company is really selling for $50M ($100–50).
Now say the earnings are $25M a year.
That should give me a PE of 4.
But say the company forecasts that in 2 years, earnings will be $50M a year.
Well, now I have a PE of 2 on $100M (50/100 = 2)
But I am only actually paying $50M to get $50M in earnings.
That’s a hidden PE of 1.
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