Mohnish Pabrai on Buffett & Munger, Value Investing and Pabrai Funds

marsh thank you very much for joining us today you're most welcome you are one of the uh noted value investors one of those who is admirer of warren buffett uh what did you take from warren buffett and what do you do differently from warren buffett you're not a clone uh well you know we will never have another warren i think warren is a very unique person and also i think that his investing prowess is so strong that many of his other attributes and i would say his other qualities get ignored uh i believe the best things about warren have nothing to do with investing but they have everything to do with leading a great life so many of the things most of i think most of the great things i've taken from warren uh have more to do with life than investing such as well such as you know uh how to uh raise a family interaction with friends the importance of keeping your ego in check you know humility just a whole bunch of different attributes the importance of candor the importance of integrity just all these the soft skills that are very important in life they do interconnect now uh in terms of how you approach an investment uh you i think to probably pay more attention to intangibles than perhaps warren buffett or ben graham might have done well warren pays attention to intangibles but ben graham was very much a tangible guy right and and yeah so we're we're looking at the qualitative as well as the quantitative and and yeah so i would say that one way to look at that is uh to consider what charlie munger would call his latticework of mental models when you look at a business look at it in a broader context of how it fits into the world and sometimes if you can see it in a light that the world is not seeing it in that can give you an edge monger also said you have three choices yes no or too difficult you subscribe to that too that's right and 98 is too difficult so uh that gets to uh knowing your areas of competency you uh you share warren buffett's antipathy to technology not that you dislike it but you just don't feel you're going to bring value-added there yeah you know my my degrees are in computer engineering i spent a lot of time in the tech industry and i like to say that i don't invest in tech because i spent time in it and i i saw firsthand that the durability of technology modes is many times an oxymoron now uh quickly define moats in terms of a business that keeps competition away well you know if you talk to michael porter he would give you five books on what is meant by uh you know strategy and competitive advantage and durable competitive advantage and if you talk to warren and charlie they would just say it's a moat and they'd break it down to one one word but basically it's the ability of a business to have some type of some type of an enduring competitive advantage that allows it to earn a better than average rate of return over an extended period of time and so some businesses have narrow modes some have broad modes some have modes that are deep but get filled up pretty quickly so what you want is a business that has a deep moat with lots of piranha in it and that's getting deeper by the day uh that's that's a great business so uh summing up in terms of what uh what do you think do you bring to value investing that others perhaps don't that give you a unique edge uh i think the biggest edge would be attitude so you know charlie munger likes to say that you don't make money when you buy stocks and you don't make money when you sell stocks you make money by waiting and so the biggest the single biggest advantage a value investor has is not iq it's patience and waiting waiting for the right pitch and waiting for many years for the right pitch so what's that saying of pascal that uh you like about uh just sitting there yeah all man's misery stem from his inability to sit in a room alone and do nothing and all i'd like to do to adapt pascal is all investment managers miseries stem from the inability to sit alone in a room and do nothing so you don't feel the need to uh pick 10 stocks a quarter or one stock a quarter it's just what turns up you know actually i think that the way the investment business is set up it's actually set up the wrong way the correct way to set it up is to have gentlemen of leisure who go about their leisurely tasks and when the world is severely fearful is when they put their leisurely tasks aside and go to work that would be the ideal way to set up the investment business you uh does this tie into your ideas and other value investors ideas of low risk high uncertainty that's right i mean i think i think the low risk high uncertainty is really something i borrowed from entrepreneurs and you know the patel's in india or the richard bransons of the world basically if if you study entrepreneurs there is a misnomer people think that entrepreneurs take risk and they get rewarded because they take risk in reality entrepreneurs do everything they can to minimize risk they are not interested in taking risk uh they want free lunches and they go after free lunches and so if you study uh any number of entrepreneurs from ray kroc to uh you know herb schultz at starbucks and uh to even even buffett and monger and so on what you'll find is that they've repeatedly made bets which are low risk bets which have high return possibilities so they're not going high risk high return they're going low risk high return and even with bill gates for example the total amount of capital that ever went into microsoft was less than 50 000 between the time it started and today that's the total amount of capital that went into the company so microsoft you cannot say was a high risk venture because there was no capital deployed but it had high uncertainty bill gates could have gone bankrupt or bill gates could have ended up the wealthiest person on the forbes 400 and he ended up at the extreme end of the bell curve and that's fine but he did not take risk to get there he was comfortable with uncertainty so entrepreneurs are great at dealing with uncertainty and also very good at minimizing risk that's the classic great entrepreneur this is your almost third career and this idea you have on uncertainty and risk you started a company it worked you sold it you start another company it did not work what did you learn from that that gave you insights on investing that those who had not been in the trenches well don't bring the first company took no capital and generated an enormous amount of capital for me then i got fat dumb and happy and my second company i put in a lot of capital you thought you know what you're doing and i violated the low risk high uncertainty principle i got my head handed to me and i got that seared heavily in my psyche and and now the the third business if you call for briar funds of business i call it a general leisure activity uh but but babri funds is again low risk high uncertainty in the sense that there is no there's no downside uh it never took capital so it's a it's a great business so as a gentleman of leisure is that why you take a nap each day at 4 pm there's nothing better do you have a nap room i wish you know when i went to when i went to warren's uh berkshire headquarters last year my friend guy asked warren uh he said warren uh monish has a nap room in his office do you have a nap room and warren's answer was yes okay so i was surprised so i said warren you're telling me in keyword plaza there's a nap room for you he says yes he says not every day but every once in a while i need to go to sleep in the afternoon there's something to do that my my father called having a conference that's right no it does wonders i i have a hard time getting past the day without the nap so the nap is a must so having those two experiences no capital then as you say fat and happy and uh then you got your head handed to you uh what uh what what when you look at an equity when you look at a possibility what do those experiences give what insight do you get from those experiences well the insight is the same in the sense that i think that uh you know warren says that i'm a better investor because i'm a businessman right and i'm a better businessman because i'm an investor so the thing is that my experiences as a businessman have very direct uh long-term positive impacts on me as an investor because when i'm looking at an investment i now look at it like the way i looked at my first business which is the first thing i'm looking at is how can i lose money on this and can i absolutely minimize my downside the upsides will take care of themselves it's the downsides that one needs to worry about which is why even the checklist becomes important but so the the important thing that value investors focus on is downside protection and that's exactly what entrepreneurs focus on is what is my downside so that is the i would say the cross the crossover between entrepreneurship and investing and value investing especially is protect your downside now uh your hedge fund manager but you're unusual first your fee structure explain that well uh you know my fee structure i i uh one of my one of my uh attributes about uh about a great investor is uh be a copycat do not be an innovator so when i started public pioneers take the arrows yeah when i started for buy funds i actually didn't know anything about the investing business and the only uh if you can call it a hedge fund that i was familiar with was the buffett partnerships and when i looked at the buffett partnerships i found that warren buffett charged no management fees he took 25 of the percent of the profits after a six percent hurdle and all of that made all the sense in the world to me because i felt it aligned my interest completely with my investors so i said why mess with perfection let's just mirror it and that's what i did and what i didn't realize at the time it took me a few years to realize it is that that mirroring created an enormous moat for pobryphons because the investors who join me will never leave because it's the first question they ask any other money manager they go to work for or they want to put money with is what is your fee structure when they hear the fee structure they say i'm just going to stay where i am and so first of all it creates a moat where the existing investors do not want to leave and the new ones who join the church are happy to join you're also unusual another way you don't seem to go out of your way to institutional investors uh yeah i mean i think i think i'm i'm looking for people who want to invest their family assets for a long period of time i really don't want investors who are looking at putting things into style buckets or are looking to look at allocations every quarter or might need to redeem in a year and those sorts of things so their the frameworks are very different so in general um so someone who comes with you is a minimum of what two years three years what uh before you allow them in exit uh our exits are annual so people can get out once a year uh but what we suggest to them is to not invest if they don't have at least a five year horizon but we don't impose any uh because people can have hardships they can have all kinds of things at home now uh low cost one of the things that apparently institutional investors are flummoxed by is uh it's you our our total uh expenses for running the funds which the investors get charged for is between 10 and 15 basis points a year that's what they pay for for all the accounting audit tax administration and and everything they don't pay for my salary or my my staff salary we take that out of the performance fees and they only pay the performance fees after six percent so what a deal [Laughter] now you're not big on schmoozing investors uh you know i think the thing is that uh every business uh ought to figure out who the ideal customer is and uh at pobrey funds what i've found is that investors who do their own homework uh find me and do the research on me on their own without any middlemen involved and then invest in for buy funds like amazon which is wire the money and send the forms tend to be the best investors in fact the investor base we have is mostly entrepreneurs who created their wealth themselves and they're very smart and they're in a wide range of industries in fact my analyst pool is my investor base so i have investors in all kinds of industries and when i'm looking at investment ideas in particular industries i can call them and i get the best analyst at the best price with no conflict of interest so it works out great free that sounds good exactly it's great you're not even registered with the sec uh i think the hedge funds so far have not had to i don't know if the rules will change if the rules change of course we'll follow the rules but you know we we have audits by pricewaterhouse we have to report 13f to the sec so i think there's plenty of disclosure and transparency you also don't engage in things like short selling you know why would you want to take a bet steve where your maximum upside is a double and your maximum downside is bankruptcy it never made any sense to me so why go there you uh we focus on a handful of individual investors maybe an institutional investors but people who know you right with you you're not part of a formula not spit out of a computer that's right uh what's an individual investor to do you have some unique advice on for for individual investment well the best the best thing for an individual investor to do is to invest in index funds but even before we go there you know charlie munger was asked at one of the berkshire annual meetings by a young man how can i get rich and mungo's response was very simple he said he said if you consistently spend less than you earn and invest it in index funds dollar cost average because you're putting in money every every paycheck he said that in about 20 30 or 40 years you can't help but be rich it's just bound to happen and so any any uh individual investor if they just put away 5 10 15 of their income every month and they just bought into the low cost index funds and just two or three of them just split it amongst them uh you're done there's nothing else to be done now if you go to active managers the stats are pretty clear 80 to 90 of active managers underperform the indices but even the 10 or 20 percent who do only one in 200 managers outperforms the index consistently by more than three percent a year so the chances that an individual investor will find uh someone who beat the index by more than three percent a year is less than one percent it's half a percent so it's not worth playing that game and in terms of index funds s p 500 or i'd say vanguard is a great way to go i think you could do s p 500 index you could do the russell 2000 and if you wanted to you could do an emerging market index but you know i think if you just blend those three uh one third each you're done and if you're in your 20s and you start doing this you don't need to even go into bonds and other things you can just do this for a long time and you'll be fine on tv when these folks make recommendations you compare it to if you buy something that you heard somebody recommend on tv is going into the roach motel please explain well you know you know you remember those ads that that ran where the roaches check in yeah but they never check out uh so the thing is you you watch some talking head on tv and he tells you go buy whatever company waste management or citigroup when its price gets cut in half he's nowhere to be found and now you're like that roach in the roach motel and you don't know what to do you don't know whether you should hang on or sell or stay so the only reason or if it goes up yeah yeah if it goes up 10 or 50 or 100 what are you supposed to do do you want to go for long term gain short term gains basically you have no road map so the only way one should buy stocks is if you understand the underlying business you stay within circle of competence you buy businesses you understand and if you understand the business you understand what they're worth and that's the only reason you are to buy a stock and looking around the world you made mention i think in the past if you want an index fund with the merging markets okay but you have a take a skeptical eye to investing uh in other countries around the world you don't preclude it but uh you see some uh well you know steve there are plenty there's plenty of great opportunities in many countries but i would say uh it's probably a no-brainer to avoid russia uh zimbabwe and uh even if you look at a place like china which i think will create incredible amount of wealth for humanity in this century um the average chinese company has three sets of books you know one for the government and one for the owner's wife and one for the owner's mistress and so the problem you have is you don't know which set of books you're looking at and so so i think uh i think in uh in chinese companies or even in indian companies uh you've got to there you have to add another layer which is you have to handicap the ethos of management and that can get very hard especially when someone like me is sitting in irvine with naps in the afternoon trying to figure that out you also say you don't think you get much uh talking to ceos because they're in the business of sales yeah you know the average the average ceo first of all the average public ceo is a person you'd be happy to have your daughter marry any five of them uh but uh they got to those positions because they have charisma and they are great sales people now you cannot lead you cannot be a leader without being an optimist so ceos are not deceitful i think they are high integrity people but if you sit down with a high charisma ceo of an oil company and he knows everything about oil and you know nothing about oil by the time you finish that meeting you just want to run out and buy all the stock of his company that you can and it's just not the right way to go about it so you're better off uh not not taking the meeting but looking at what he's done over the last 10 or 15 or 20 years so not being mesmerized by charisma will probably help you and what areas are you looking at right now you uh i remember in back in 1968 69 we did a story on buffett when he was fairly unknown and he was getting out of the market by the bull market of the 60s five years later after the crash of 73-74 we went out to see him again to see what he was saying after the market had gone down 50 60 percent and he politically incorrectly said that he felt like a sex maniac and a harem right of all the bargains around you probably had the same feeling a year ago uh what do you what do you see uh what how how does the harem look now that's right in in 1969 warren told you that i feel like a sex starved man on a deserted island and in 74 the deserted island had become a harem right um well nowadays we're twiddling our thumbs uh it's it's it's good that i enjoy playing racquetball and uh and uh and bridge and so on so there's a lot of bridge there's a lot of racquetball and and you know i have an eye out on the markets but there's just not a whole lot of value presently but but value can show up tomorrow for example so so we're not in a hurry uh happy to have a leisurely lifestyle and wait for the game to come to us so on the first quarter of 2010 did you add any positions yeah actually we did we did find in fact there's one i'm buying right now but i i found two businesses with the anomalies they were just uh you know businesses that had uh distressed in them because of specific factors and i think we'll do very well on both of them they'll go nameless here but uh but no uh i don't i think for example in the fourth quarter of 2008 or the first quarter of 2009 you could have just thrown darts and done well and uh that is definitely not the case today and uh finally uh talking about mistakes one of the things i guess investors to realize they cannot control the universe uh delta financial you had done the homework you fell with it and then events took it away from you well delta financial was a full loss for the firm for the for the fund we lost 100 of our investment it was a company that went bankrupt and uh we've learned a lot of lessons from delta and one of the lessons was that uh delta was in many ways a very highly levered company and they were very dependent on a functioning securitization market and when that market shut down they were pretty much out of business and uh and they were caught flat footed and uh so there's a number of lessons i've obviously learned from from delta was it's it's easier to learn the lessons when you don't take the hits in your own portfolio but when you take the hits in your home portfolio those lessons stay with you for a long time so that gets to you're a great fan of the checklist manifesto and you now have checklists what what you said one of the key things is mistakes in terms of a checklist so you don't let your emotions get in the way of analyzing what are some of the mistakes on your checklist now that you go through systematically even if your gut says this is great i want to do it yeah so the checklist i have currently has about 80 items on it and even though 80 sounds a lot like a lot it doesn't take a long time it takes about 30 minutes to go through the checklist what i do is when i'm studying a business i go through my normal process of analyzing the business when i'm fully done and i'm ready to pull the trigger that's when i take the business through the checklist and i run it against the 80 items but what happens the first time when i run it is there might be seven or eight questions that i don't know the answer to uh which is great which what that means is listen dummy go find out the answer to the eight questions first so which means i have more work to do so i go off again to find those answers when i have those answers i come back and run the checklist again and any business that i look at is going to have some items on which the checklist raises red flags but the the good news is that you're looking in front of you with all the with all your facilities at the range of things that could possibly cause a problem and when you look at that list you can also compare it to how those factors correlate with the rest of your portfolio and at that point uh kind of you have a go no go point where you can say i'm comfortable with this risk factors here i come i'm comfortable comfortable with the prior probabilities and i'll go ahead with it or or you can say i'm just going to take a pass and one of the things that came out of running the checklist was i used to run a 10 by 10 portfolio which is when i'd make a bet it was typically 10 of assets and after i incorporated the checklist i started to see all the red flags i changed my allocation so the typical allocation now at pablo funds is five percent and we'll go as low as two percent if we're doing a basket bet and once in a blue moon we'll go up to 10 in fact i haven't done a 10 investment in a long time and uh so the the portfolio has become uh more names than it used to have but since we started running the checklist which is about 18 months ago so far it's a zero error rate and in the last 18 months it's probably been the most prolific period of making investments for forbry funds we made a huge number of investments more than any other period any other 18 month period in the history so with more activity so far it's a very short period we have a much lower error rate i know in the future we will make errors but i know those errors the rate of errors will be much lower and this is and this is key the thing is that warren says rule number one don't lose money rule number two don't forget rule number one okay so the key the key to investing is downside protection the upsides will take care of themselves but you have to make sure that your losers are few and far between and the checklist is very central to that can you give a couple of the things that are on your 80 items oh yeah sure there's a the checklist was created looking at my mistakes and other investors mistakes so for example uh there's questions like you know can this business uh be decimated by low-cost competition from china or other low-cost countries that's a checklist question another question is is this a win-win business for the entire ecosystem so for example if there's some company doing uh you know high interest credit cards and they make a lot of money uh that's not exactly you know helping society so you might pass on that or if there's a liquor company or tobacco company those can be great businesses but in my book i would just pass on those uh or a gambling presence and so on so uh so the checklist will kind of focus you more towards being playing center court rather than going to the edge of the court uh and there's a whole set of questions on leverage uh for example you know how much leverage what are the covenants is it recourse or non-recourse there's a whole bunch of questions on management on management comp on the interest of management on you know just a whole on their historical track records and so on so um there's a number there's questions on unions uh on collective bargaining so that so you know uh and and all of these questions were not questions i created out of the blue what i did is i looked at businesses where people had lost money i looked at dexter shoes where warren buffett lost money and he lost it to low-cost chinese competition so that led to the question and i looked at court furniture which was the charlie munger investment and that was a investment made at the peak of the dot-com boom where they were doing a lot of office furniture rentals and the question was are you looking at normalized earnings or are you looking at boom earnings and so that's that question came from there so the checklist questions uh i think are very robust because they're based on real world uh arrows people have taken in the back terrific thank you well thank you steve

Channel: The Financial Review

Views: 18,557

Rating: 4.9703703 out of 5

Keywords: warren buffett, charlie munger, berkshire hathaway, intelligent investor, investment, stock market, mohnish pabrai investing

Id: kAcxW0t0hcQ

Length: 29min 58sec (1798 seconds)

Published: Wed Mar 24 2021

Reddit Comments

[u/RecommendationNo6304]

Never really paid any attention to Pabrai. He gets straight to the correct answer immediately. I've had that same thought dozens of times.

When's the last time you heard Buffett speak bad about someone else? Not sure I ever have seen it - even after people have attacked him personally.

I'm sure his general intelligence is far about average, but his people skills and social intelligence are off the charts. Lots of other people, including his partner Munger, do not have this reserve.

[u/LSUTigers34_]

I love his thoughts on this, but I’ve always had trouble reconciling it with the circle of competence requirement. This seems to be an exception to the rule.