Mohnish Pabrai is widely considered to be one of the best value investors managing money today. He runs the Pabrai Investment Funds, a group of hedge funds modelled on Buffett’s original partnerships.
Returns since inception have been highly impressive. $100,000 invested with Pabrai on July 1, 1999 (inception) was worth $1,164,600 at the end of 2018, a compound annual return of 13.4% net of fees.
I’ve learned quite a bit from reading and listening to Pabrai’s advice over the years, and the one lesson that I think has helped me more than most is his guidance on using an investment checklist.
According to Pabrai, his checklist has around 150 items on it, and a company must pass all before he invests. The list is an aggregation of other investors’ mistakes following Charlie Munger’s guidance to “invert always invert.” By avoiding the situations where other investors have lost money, Pabrai hopes he can avoid falling into the same traps.
And the most common mistake investors make? Well, that’s buying companies which rely too much on leverage. As he described in a recent podcast with Gurufocus:
“The number one place where I have gone wrong, as well as other investors, is leverage. The way I make my checklist, I only put items on the checklist where some great investor has made a mistake, and that mistake was obvious, before the investment…On the checklist, the number one area where most problems have come up for investors and have been a problem for me as well if I look back over the past 25 years, the biggest area where I have lost money has been levered institutions. What I have learnt is, to be very careful when going down that path. In fact, the best business our the ones that can make a lot of money with no leverage. So, leverage has been a problem for most investors and for me.”
In another interview, this time with Forbes in 2018, Pabrai explained that a good chunk of the questions on the list concern leverage:
“The biggest area of why business or investments don’t do well is leverage. Leverage is generally the one that I’ve had the most difficulty with in the past. There are a host of questions related to leverage, debt and that genre. The second area is a toss-up between management and ownership or comparative advantage and the durability of the moat. Those three areas, leverage, management/ownership, and comparative advantage/moats, make up 70-80% of my checklist.”
Some of the best investment lessons are those that are easy to understand and simple to operate. This is one of those. Sure, you might miss out on some profits if you avoid all leveraged companies, but you are bound to save yourself from big losses as well. I think that is a trade worth making.