Finding the Next Deep-Value Winner

Value investor Mohnish Pabrai had a huge success Monday with one of his holdings, Harvest Natural Resources(HNR).

The Venezuelan oil company was up 37% on news that Venezuela would restructure HNR's in-country operations so that the Venezuelan government would be a majority owner. The market abhors uncertainty, and now that we know what will happen with HNR's oil properties in the country, the stock came out of its range and shot up.

I had been following the stock for a while, and I've had great success with other Mohnish Pabrai plays, but I could never quite get behind this one because of concerns about Venezuela. Pabrai, a noted deep-value investor in the Warren Buffett tradition (see my interview with him in Trade Like Warren Buffett) stuck to his guns and won big.

Every one of the companies in his portfolio seems to have two qualities: deep value (as measured by a low multiple over assets or earnings) and a slight taint of scandal or uncertainty.

For example, let's look at gambling software company Cryptologic(CRYP). The company has $102 million in cash, no debt and a $344 million market cap, which means almost a third of its market cap is in cash. Additionally, it trades at just 8 times EBITDA.

It's dirt cheap, but there is a lot of uncertainty about whether or not the U.S. will revisit whether to make online gambling legal in the U.S., which would be a big boon to companies such as Cryptologic and also Optimal Group(OPMR). The Freakonomics Poker Portfolio contains other stocks that would move positively if online poker is made legal in the U.S.

Another deep value play in Pabrai's portfolio is FreightCar America(RAIL), which has $184 million in cash, no debt and a $620 million market cap. Recently, super hedge funds SAC Capital and Citadel Capital have been loading up on this stock.

HNR also appears on another interesting portfolio, Top 10 'Magic Formula' stocks. The Magic Formula refers to hedge fund manager Joel Greenblatt's technique for finding value plays, as described in his book The Little Book That Beats the Market. In it, he describes a technique for finding stocks that are good (as defined by high return on equity) and cheap (as defined by a low price/earnings ratio). This portfolio also includes OmniVision Technologies(OVTI) and True Religion Apparel(TRLG).

For Pabrai's top positions, go to the Mohnish Pabrai portfolio on Stockpickr.

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