Why you Should Never use an Excel Sheet!

“When researching a company, keep looking for reasons to say ‘no’ to that company.”

-Mohnish Pabrai

Before we start, I must apologize for changing my mind. In another post I argued for the use of an intrinsic value calculator that I created. The basis for any intrinsic value calculator—let’s call their calculations, quantitative descriptions—is founded on the assumption that we can develop a rough estimation for our returns from an investment. If we have a rough estimation, we can implement a margin of safety on that estimation for security, and through that, we can find out whether a company is “underpriced” or “overpriced” compared to the market. But recently, after thinking quite a bit, I feel that I was wrong in placing so much weight on quantitative descriptions.

Mohnish Pabrai, the “Indian Warren Buffet,” holds as one of his rules: “If you have to open an excel sheet, say no to the company.” His reasoning is that good companies should be no brainers. If the decision between a handful of companies is “up in the air” then automatically decline the lot. It is rare to find so many great companies that a quantitative analysis would decide which company to invest in. Not only that, but if two companies are ever so close in quality, then vague estimations from a quantitative analysis may be of no use. Quantitative calculations may provide overlapping margins of safeties, and a decision made from these overlaps would only have utility in calming one’s anxieties from choosing between companies. We may as well just flip a coin in this regard, and call the outcome "divine providence" so that we may reduce our anxieties. Vague estimations that are precise have no meaning since the actual intrinsic value will change due to impossible to foresee future events.

Usually, good companies have qualities that make them stand out without using data analytics—such as having no debt, having consistent and amazing earnings growth, high returns on investments, and contracts guaranteeing profits for a set number of years (all without having any red flags—and ideally selling at an obvious discount). A company like this is extremely rare. If you find an impossibly great investment with due diligence, and then moved on to research another company, then what are you doing? Do you not see a great buy when it smacks you in the face? Why are you being that picky? (Well, maybe you have no cash, but even then--a comparison between two companies shouldn't be decided through precise figures)

I am of the mind that great companies, selling fairly, are more profitable than finding good companies selling at a discount. I do not have the experience or the years’ time to test this hypothesis, but if Peter Lynch, Mohnish Pabrai, Warren Buffet, and Charlie Munger think this way—Then, shouldn’t we? One exception would be guaranteed profits, with a very clear hypothesis, such as:

There is a contract in place guaranteeing a $10 million profit for the next two years, and the market cap of the stock is only $12 million. So, the value of the company will expand to almost twice its current worth next year, and by 50% the next year. Let us buy and hold for at least a year and see if this is true.

I assume that "looking for cigarette butts" which is Buffet's way of saying looking for good companies selling at a discount, may be more analytical. A great company should stand out and be rare. But good companies selling at discounts can only be found through analyzing a financial statement where some footnotes may indicate hidden gold nuggets. But the gold mines are not found this way, according to Buffet and Pabrai. Buffet used to "look for cigarette butts" and he said that it was a way to make money, but the real money comes from finding amazing companies.

Now I hear your worries with my change of mind: But Warren Buffet himself, the grandmaster, came up with the DCF model that other investors use to calculate intrinsic worth. Are you saying that Pabrai is more right than Buffet when he said “If you have to open an excel sheet, say no to the company?”

Well, Buffet himself doesn’t open excel sheets either, as far as I know. When he announced the DCF model, it was only after being pressed by his investors to explain how values companies. He did not actually use the model when choosing his rare investments, such as Coca Cola. He chose Coca Cola based off of qualities, not quantities. He saw continuously increasing revenues, and a brand name that could not be beat even as it invaded new countries.

Investment decisions, while entirely reliant on “numbers” in financial statements, are actually qualitative decisions. The numbers are simply indicators to the worth of a company. So, when we find a Great investment, it is because the numbers and other intangibles such as its management and branding indicate great qualities. Pabrai and Buffet would explain their investment decisions in terms of the whole i.e. “Because it has a great management team and great fundamentals etc.” They don’t say “well the earnings were $2 million, and the market cap was $6 million, which is better than its competitors who earn $2 million and have market caps at $7 million… etc.” They would only speak like this if they wanted to show a quantity that indicates an obvious conclusion in quality like, “this company has a market cap of $1 million and they are earning profits of $7 million a year.” A company with a market cap of $1 million producing profits of $7 million is a shining unicorn and is either a scam or will not have a market cap of $1 million for much longer.

So, to come back around to Pabrai’s point, if you have to open an excel sheet, it is because the company you are looking at is not obviously a good company. If the numbers are up in the air for whether a stock is under or overpriced, then do not buy it. You should be able to tell if the stock is under or overpriced just by looking at the raw numbers and other fundamental qualities.

As an Update: I still have zero leads on where to invest my money. I should probably have at least 2 and at most 4 companies that I think are very promising before starting a fund. For now, I will keep looking and keep on expanding my circle of competence. Semiconductors seem interesting right about now. My next post will be more substantive and analytical as I delve deep into the semiconductor industry.