(Extracted from The Dhandho Investor by Mohnish Pabrai)
Wall Street sometimes gets confused between risk and uncertainty, and you can profit handsomely from that confusion. The Street just hates uncertainty, and it demonstrates that hate by collapsing the quoted stock price of the underlying business. Here are a few scenarios that are likely to lead to a depressed stock price:
- High risk, low uncertainty
- High risk, high uncertainty
- Low risk, high uncertainty
The fourth logical combination, low risk and low uncertainty, is loved by Wall Street, and stock prices of these securities sport some of the highest trading multiples. Avoid investing in these businesses. Of the three, the only one of interest to us connoisseurs of the fine art of Dhandho is the low-risk, high-uncertainty combination, which gives us our most sought after coin-toss odds. Heads, I win; tails, I don’t lose much!