MALE SPEAKER: Welcome everyone.
Anyone who has read "An Annual
Letter of Berkshire Hathaway"
has often come away marveling
at Warren Buffett's ability
to distill complex concepts
into very intuitive language.
Our speaker for
today, Mohnish Pabrai,
is someone who paid
$650,000 for a lunch
with Warren Buffett in 2007.
It's a sum he calls a bargain.
And in the same spirit as Warren
Buffett and Charlie Munger,
he has a very intuitive, very
evocative, very emotionally
appealing way of
distilling complex concepts
into his form of connecting
with the audience.
He is probably a
fantastic teacher,
although he does not
carry that official title,
if you go by any of
his presentations
to various university groups.
Our speaker from last
time, Michael Mauboussin
spoke about the role of
luck and skill in life.
He spoke about how
there is not often
a linear cause and effect
chain, but a spectrum
of probabilistic
outcomes in life.
Mohnish takes that
one step further.
He talks about
being preferential
towards probabilistic
scenarios where
you have a limited downside,
but a disproportionately
high upside.
Also I could go on and on
about his investing philosophy,
his philanthropic activities,
so on and so forth.
But I think what we'll
see here is how he really
cares about connecting
with the audience
and how good of a teacher he is.
So without further ado,
ladies and gentlemen,
please join me in
welcoming Mohnish Pabrai.
MOHNISH PABRAI: Thank you.
Thank you, Sarab.
That's a wonderful warm welcome.
Very much appreciated.
And it's pretty
exciting for me when
we got the e-mail from
Sarab about the possibility
of speaking at Google.
Because it's easy to be a fan.
And I think it's a
wonderful company.
In fact, I think in many ways
in the end, when we look back,
I think Google might very well
be the greatest company ever
created, for a
variety of reasons.
And one of your board
members-- he's not a friend,
he's an acquaintance of mine.
And I'd asked him
a few years back,
so what's the next Google?
And his response, he instantly
said the next Google is Google.
And I think that's
a great reply.
Because I think that the way the
company is designed-- you know,
Warren Buffett always says
that investing in businesses
with rapid change are the
enemy of the investor.
In many ways, Google is kind of
future-proof from that vantage
point, just because of
the way it's structured.
And so it's quite exciting
to be outside the Plex
and look in and see all
the great stuff going on.
So anyway, from a
number of perspectives,
I'm delighted to be here.
And I'll always kick
myself for never
investing in Google stock.
But there's still time, and we
might still get there one day,
so we'll see.
So the Dhandho
investor, the book
that came out a few years
back, Buffett has a quote.
He says I'm a better investor,
because I'm a businessman.
And I'm a better businessman,
because I'm an investor.
And in essence, that book,
the Dhandho investor,
is the expansion of that one
sentence into 100 plus pages,
basically delving into
that particular nuance.
And the word Dhandho
is a Gujarati word.
And do we have any
Gujaratis in the room?
Oh, we have one.
One Gujarati?
All right.
That's good.
So people always think
I'm from Gujarat in India,
because I wrote a book
called the Dhandho Investor.
And I have to always correct
them and say, I'm not Gujarati.
I had a roommate from
Gujarat, and he--
when I was doing my
undergraduate in engineering
and he was also an engineering
major-- he used to disappear
on weekends, because
all his family,
extended family, had all
these motels, and laundromats,
and gas stations,
and whatnot that they
owned in the Carolinas.
And then he'd come
back on Sunday night,
and he'd be bursting
with all these stories
about the new investments
his family had made,
and all of the economics
of those investments.
And then in the end,
he would finish and say
Mohnish, Dhandho.
And that was his way of saying
that-- the literal transition
the word Dhandho means business.
But the way the Gujaratis
use it, what it means
is, it's a way of doing
business where you basically
have upside with almost
a nonexistent downside.
Which is the key to investing.
Like Buffet says, rule
number one, don't lose money.
And rule number two, don't
forget rule number one.
So that was kind of the backdrop
behind the title and the book.
And Indians make up about 1%
of the population of the United
States.
A little over 3 million people.
And the Patels, who
are from Gujarat
are a much smaller
portion of that 3 million.
My guess is they would
probably be less than 1/5
of 1% of the US population,
well under half a million or so.
And even though
they're that small
a portion, probably
more than 60%
of the motels in this country
are under Patel ownership.
And that's a stunning
statistic, considering
that 40 years back there
were no Patels over here.
So they went from
basically a standing start
to pretty much
dominating this industry.
And they've moved up markets.
So they used to be
at the lowest end--
the smallest 10, 20, 30
room type highway motels.
And now, they're buying the
Marriott's and the Westerns
and the Hiltons and all that.
So they're kind of
moving up the chain.
And they came to the
United States as refugees,
and most of them came from
East Africa, from Uganda.
And at that time,
in the early '70s,
there was a dictator, Idi Amin,
who came into power in Uganda.
And the Patels actually had
come to Uganda several decades,
more than 100
years, before that.
And they came mostly
as indentured laborers.
But over time, using
their Dhandho techniques,
they pretty much
controlled large portions
of the Ugandan economy.
And Idi Amin was very
pissed off about that.
And his perspective was
that Africa is for Africans.
And so what he did is he
pretty much nationalized
all their assets and took over
all their personal property
and threw them out
of the country.
So there was
stateless, actually.
They really had
no state to go to.
India was reeling from
the Bangladesh war and all
the refugees coming
from Bangladesh.
So India actually refused to
take the Patels in as refugees.
England took some.
In the United States, at that
time, the Nixon administration,
they were quite
familiar with the issue.
And they were sympathetic
to the plight of the Patels,
but they were limited.
So the United States took
in a few thousand Patels.
A few more thousand
came to Canada.
And most of these Patels
who showed up in the US
in the early '70s
didn't have that
much in the way of education.
And the only money they could
really carry with themselves
were whatever they could
convert into gold quickly,
a few thousand dollars.
So that they landed up
in the United States.
And they really found that they
had virtually no skills which
were of use to most employers.
They had a heavy
accent, and really
didn't have much
in terms of skills.
But they found that
motels, buying motels,
was a great way to go.
And the reason they thought
that was because a typical Patel
family, at the time, could buy
a 10 or 15 room motel for well
under $100,000, maybe
$50,000 to $75,000.
And the family could live in
one or two of those rooms.
And because motel
are labor intensive,
they would pretty much
fire all the staff,
and the family would
do all the work.
So laundry, cleaning rooms,
watching the front desk.
Everything was done by
different members of the family.
And they became
low cost operators.
They looked at every single
facet of the business.
And so once a motel came
under Patel ownership,
two things happened.
One is that the
operating cost dropped.
And because the operating
costs were lower,
they were able to charge lower
rates and increase occupancy.
And so typically,
the Patel owned
motel in a particular area would
always do economically better,
in terms of cash flows, then the
other non-Patel owned motels.
And as soon as they
had enough cash flow,
they would buy the second
motel, and then the third motel.
And they'd just keep levering
them and buying them up.
And we end up with the
result of where we are today,
where they pretty much
dominate the space.
And that aspect to the way they
went about doing their business
has a lot of correlation
with investing.
Because the whole
Buffet sentence
of being a good businessman
is a great skill
set to be a great investor.
And the particular
facet that they
followed was this notion
that I call "heads I win,
and tails I don't lose much."
So if you looked at the
economics of a Patel
buying a motel, typically they
would put $5,000 or $10,000
down.
And most of it was a bank loan.
And if for some
reason they were not
able to manage the cash
flows, the banks really
would prefer not to take the
motel back, foreclosing it.
They would prefer or do
what they did recently
in the financial crisis,
extend and pretend.
Keep the same guy running it
and hope that things improve.
So either way, the end
result was the Patels,
even with high leverage,
were unlikely to lose
their properties.
And they didn't.
Because they were
smart operators,
they got nowhere near that mark.
And after a few years,
the banks actually
wanted to lend to motels
under Patel ownership,
because they saw the
default rates and all
that were markedly
different than the rest
of the population.
And so that worked out
quite well for them.
And there's this
notion that it's just
the Patels that have this
tight-fisted way of operating,
and this "heads I win,
tails I don't lose much."
But it actually
is available to us
anywhere we look, and you find
it in all kinds of places.
So for example, if you look at
Richard Branson in England, who
is as far away from the
Patels as you could think of.
And if you examine
the way Branson runs
his different businesses,
they're very much in sync
with the Patel model
of operating with
"heads I win, tails
I don't lose much."
So for example, before the
formation of Virgin Atlantic
airlines, Branson used to
be in the music business.
He was a publisher of music.
And these different [INAUDIBLE]
like Boy George and the Sex
Pistols and so on were
some of the brands
that he had brought up.
So one day he goes
to his partners
and says that he wants
to start an airline.
And he wants to basically fly
between London and New York,
and that he thinks it's a
great market to go into.
So his partners
were quite floored.
They said look, we're doing
very well in the music business.
We know nothing about
the airline business.
You need a jumbo jet to get
into the airline business.
And that jumbo jet costs
about $200 million.
We don't have $200 million,
and we don't know anything
about the business.
So he says, well, someone
sent me this business plan.
And Branson was smart.
He said that if an executive
in the music business
gets a business plan to start
an airline flying between London
and New York, you know
that this business plan has
gone to 300 other
places before that,
and got turned down at every
place that knew anything
about the business.
But he was intrigued
by the plan.
And he tried calling British
Airways over the weekend
to try to book
some flights, just
to see what the customer
service was like.
And he couldn't get through.
So he said, well either
there's so much business
that there's enough there for
a second player to come in.
Or they're so bad
that a second player
can come in and do a better job.
Either way, there's
room for that.
And then his partners told
him that, yeah, that's
all fine Richard.
But we don't have the money.
We don't have the jet.
We don't have a jumbo jet.
How are we going to do this?
And so what he did is, he
called (206)-555-1212--
which is the
operator in Seattle--
to get the number for Boeing.
And they gave him the
Boeing main phone number.
And he called
Boeing, and he said
he wanted to speak to someone
who leases jumbo jets.
And they'd repeatedly
hang up on him.
And finally, he
got to some guy who
would actually speak to him.
And he said, look, we typically
have one or two customers
in each country.
We know who they are.
You're not one of the people
we talk to in England, goodbye.
So he said, no.
No, listen.
Before you hang up, do you
have an old, used jumbo
that you'd lease to one of these
customers if they came to you.
He said, well, you're
not one of them.
But yeah, if they came
to us, we actually
do have an old
jumbo lying around.
He said, oh, well if these
people came to you, what
would it cost to
release the jumbo?
And so the guy mentioned
the pricing and such.
He said, would you do
a short term lease,
because the jumbo is
just sitting there.
He said, yeah, we'd be
flexible with our customers.
So he convinced Boeing
to lease him that jumbo.
Because it was
just sitting there.
And then, in the
airline business,
before the plane takes off,
you've sold all the tickets.
So your revenue comes in
before you've spent a dime.
And then you pay
for the fuel 30 days
after the plane has landed.
So it's a negative
flow business,
in the sense that you don't
need even working capital.
And so he went
about advertising,
and got the staff hired,
and got everything going,
and got this airline
off the ground.
And if you think
about it, if someone
can start a business in a
tightly regulated industry
like aviation, with
very high Capex needs,
like needing these
jumbos, with no capital,
then you can pretty much say
you can do that in any business.
Right?
And if you think about
the way Branson set it up,
he had no downside.
Because what would happen
if the thing didn't work?
Well he'd just
return the airplane.
And it'd be a few
thousand dollars
in terms of tens of
thousands or whatever.
And his music
business at that time
was producing about $3 or $4
million a year in cash flows.
So they had more
than enough money
to take care of
any eventualities.
And that's the
nature of Dhandho is
that you're making
these asymmetric bets.
And one of the
reasons why I think
Google is such a fascinating
and incredible place-- because I
don't think Sergey
and Larry ever
thought about it
in these terms--
but Google is the
ultimate, Dhandho business.
And the reason it's the
ultimate Dhandho businesses
is if you look at, for example,
your self-driving cars.
So the self-driving cars,
the real Capex on that
would come when you need
to build large scale
factories to produce
millions of cars.
It is not when you're doing
the R&D for those cars,
or have a few
prototypes, and put
a few dozen engineers on
it, and that sort of thing.
So if you think of the
outflows or outlays Google
has on the self-driven
car, I would
bet you're probably spending
more on food on the campus
then you're spending on
the self-driven cars.
And so it's an asymmetric bet.
Right?
It's basically if it doesn't
work, it has no impact.
No impact on cash
flows or anything.
And if it does work,
it's game changing.
Same thing with Android.
You know, a few
years back, Android
with a project like
the self-driven car is.
And it moved from being one
of those outlier projects
to very much central
and cash flow.
And then, even when you
look at your balloons
with the internet access, or
all the different other projects
that you guys are working on
it, basically each one of those
has the potential to
be a game changer,
in terms of where
the world ends up.
But none of those have
costs associated with them
that have anything
to do with how
threatening the
company in any way.
Right?
I mean it's a rounding error
in terms of the cash flows
that the company produces.
So the fact that the DNA
of a place like Google
is able to do things which
are not in adjacent fields,
it's quite spectacular.
And most other companies
don't have the DNA
to be able to do that.
And my two cents
looking from the outside
is, probably the
only other business
I see that has the ability
to do that is Amazon.
And I think in the end, you
will meet them head to head
on a number of different fronts.
So that's why it's
a great place to be.
And the other notion I just
wanted of talk briefly about
is this notion of compounding.
So can we play that video?
We'll just play maybe a couple
of minutes of this video,
and then I'll just
talk about it.
[MUSIC PLAYING]
OK.
So you know this notion
about confounding,
and you saw that slide
with Albert Einstein,
saying compounding is the
eighth wonder of the world.
There was this guy who
invented the game of chess.
And the King was so
excited about the game,
and became an addicted
player, that he
told the inventor you can
ask for anything you want,
and it will be yours.
And the inventor of the
game just says, I just
want you to put
one grain of rice
on the first square
of the chess board.
And then put two grains of
rice on the second square.
And then keep doubling
the grains of rice
until you get to
the 64th square.
And that's all I want.
And that emperor clearly
was not smart enough
to be employed by Google.
And he was mathematically
challenged.
So he basically got upset
with this inventor--
I wanted to give you
all these things,
and this is all you
want, a bunch of rice.
So the guy says, yeah,
that's all I want.
So he tells his treasury,
you know, measure out
the rice for him, and
get him out of my court.
And after a week, when the
treasurer was still not done,
he asked him what
the problem was.
He said well, you
know, it took me awhile
to run the calculation,
but we don't have the rice.
In fact, he said that there's
not enough rice in the kingdom
or even on the planet
to fulfill the request.
And the amount of rice, it
becomes 2 the 64 minus 1,
which is a long,
Google-ish kind of number.
In today's dollars, it's
about $300 trillion.
And I think that is
just about global GDP.
Actually, not global
GDB, but global wealth.
So if you took the wealth of
every man, woman, and child
on the planet,
that would be about
equal to the 64 minus
1 grains of rice.
So that's the power
of compounding.
Right?
It grows dramatically.
And when I heard about Buffett
for the first time in '94,
he had been compounding for
about 44 years at the time,
from about 1950 to '94.
And when I looked
at the track record,
it dawned on me that
he was moving basically
to the next square in
less than three years.
He had averaged for the first
44 years about 31% a year.
So if you compound
at 26% a year,
then your money doubled
every three years.
And of course, if
you were doing 31%,
then you were going even faster.
So basically, that
is at the essence
of the genius of
Buffett and Munger,
is they absolutely understand
the power of compounding.
And they basically
have gone at it
with this very long
runway and such.
And of course, if you look
at it from 1950 to 2014,
it is no wonder
that Buffet ends up
as the richest
guy on the planet.
Because if you keep compounding,
that's what ends up happening.
So that's one of the
important takeaways
I took from the
learnings from Buffett
and Munger is that
you don't really
need to do extraordinary things
to get extraordinary results.
If you can double your
money every three years,
then a few doubles starts
adding some significant numbers.
If you start with a million
dollars, in 30 years
it becomes a billion.
If you start with $10,000
it becomes $10 million.
It's just incredible, in
terms of what happens.
And the doubling
every three years,
my way of thinking of
that was that if you
buy a stock at less than
half of what it's worth--
and you just sit on it,
and in two or three years
it gets to being what it's
worth-- lo and behold,
you'll have your
20%, 30% annualized.
And sometimes, you
might get it in a year.
And sometimes, you
might have mistakes.
And the blended result of all of
that ends up being where it is.
So I think compounding is
a very powerful notion,
very much in sync with the
whole Dhandho framework.
And one other thing
I wanted to mention
is, just in the same kind
of mindset of Google,
is that the market gets confused
between risk and uncertainty.
And it kind of confuses
one for the other.
And risk and uncertainty are
two very different things.
And in general, anytime
you get to a situation
where risk is low, but
uncertainty is high,
in general, the odds are high
that the stock in question,
or business in question,
will be mispriced.
And it'll probably
be under-priced.
So that combination of low
risk and high uncertainty
is a great combo.
The low risk means that
your downside is limited.
And a good way to
think about that
is, for example, when Bill
Gates started Microsoft,
people always think
about these companies
being formed as being
highly risky ventures.
But if you really analyze it,
so when Gates started Microsoft,
he did not have a net
worth or assets or capital.
So the fact that he
was taking a high risk,
well, there's no
capital to lose.
So you can't really have risk
because of a loss of capital.
And if you think about
the opportunity cost,
so he had not yet finished
his undergraduate degree.
At that time, with
the couple of years
that he had spend at Harvard,
his value in the job market
was very low.
So if he went out looking
for jobs and such,
people would not be willing
to pay him that much.
And if the venture
did not work--
so he moved to New
Mexico, starts Microsoft.
And so if you think
about the notion
that Microsoft doesn't work,
well, he goes back to Harvard,
finishes an
undergraduate degree.
And now, when he graduates,
he's got interesting stuff
on his resume-- what he did
in New Mexico for a year.
So any way you look at it,
the startup of Microsoft
was almost risk free.
But the uncertainty related
to Microsoft was very high.
It could've been that
the company failed,
and whatever little
money he had was gone.
Or it could be that he could
have become the wealthiest
human on the planet,
which he did.
And so it's a very
wide range of outcomes
that could happened
to that point.
But the key thing was
that the risk was low.
And in fact, if you study
non-venture backed start-ups.
Non-venture backed
start-ups, like the Patels,
do not take risk.
In fact, if you repeatedly
study businesses,
there's more than a
million businesses
that get started in the
United States every year.
Less than a thousand of
them are venture backed.
Maybe a couple of thousand.
So 99+% of businesses that get
formed in the United States are
not venture-backed businesses.
And most of them follow this
low risk, high uncertainty
principle when they get
going, like the Patels.
So it's important
to keep in mind
that, I think you can replace
capital with creative thinking,
the way Richard Branson did.
And certainly, for
most businesses,
you don't even need the capital.
And certainly in a knowledge
economy type business,
capital actually becomes
useless, if you will.
So I can keep going,
but I think with that,
what I'd like to do is
to really hear from you,
and just see what
you have in mind,
and maybe try to
address questions
or comments along those lines.
So I'll open it up for
all of you to talk.
MALE SPEAKER: So thank
you so much Mohnish.
MOHNISH PABRAI: Sure.
MALE SPEAKER: And we'll open
up the floor for questions.
AUDIENCE: I have heard phrases
along the lines of "beware
of geeks bearing spreadsheets"
from people like Buffet.
Is there something specific
that technically-minded people
should be aware
of with investing?
MOHNISH PABRAI: I mean, I would
say that there are these-- what
I just talked about with the
issue of uncertainty, right?
So normally, engineers
want to see precision.
And you've got to
actually be open to things
where you may not
have all the answers.
In fact, by
definition, investing
is a very uncertain exercise.
Because what you really
need to do is you
need to extrapolate what the
future cash flows of a business
are going to be, and then
bring them down to the present,
and then decide whether
that works or not.
And in many cases,
in many businesses,
I would say that
there's probably
nobody on the planet, including
the founders of Google,
who could tell you what
Google's cash flows are
going to be five years from now.
But for example, if you could
put a floor on those cash
flows, then that might
give you a basis to invest.
Because you would say, OK,
I know what my downside is.
And floor on cash
flow is a lot easier
than actually predicting
the cash flows.
Right?
And so if you can, with
a high probability,
start putting floors on things--
So I think the engineering
mindset needs to change a bit.
And to some extent,
actually, Google's done that.
If you look at
your server farms,
you've gone with unreliable
hardware with high failure
rates and all of that.
And to some extent,
unpredictable times,
and places, when
things can fail.
But that's built into the
engineering of the solution.
And so you're able
to accommodate
a high degree of uncertainty.
So you don't know
which server is
going to fail when, but
I think statistically,
you know how many will fail.
And you can kind of
design around that.
So I think as long as you
can deal with uncertainty,
with generally.
And the second thing is
that, you're probably
best off never touching Excel.
Right?
So Excel has nothing
to do with investing.
And so that might be
heresy at Stanford Business
School or something.
But the way to really
look at investing
is that when you look at,
again, a business like Google,
or Microsoft, or
Berkshire, you really
have to put yourself in
the shoes of the people
running the business.
And you have to ask yourself,
how do they run the business?
Do they run it through
a set of spreadsheets?
Or how do they run it?
And I would bet that
most of these businesses
are run in a manner where the
founders or CEOs are really
looking at three to five
variables that dominate
most of their thinking,
and outcome, and direction.
And so, as an
investor, you've got
to hone in on the
same variables,
So if you can get to
the same variables--
if you're going to
invest in Microsoft,
you can get to
the same variables
that [INAUDIBLE] is using.
And Google it you
get the same variable
that Larry and Sergey
are using, then
you're getting very
close to trying
to figure out what
the business might do.
And from there,
you can extrapolate
whether it's under priced
or fairly priced, and so on.
So that's what I
would suggest, is
avoid the use of spreadsheets,
and avoid precision thinking.
AUDIENCE: Can you maybe
give us an example--
it may not be current-- where
you've looked at a business,
looked at an
industry, and said, I
think if I want to
analyze this business,
here are the three
variables that I
think are the most important.
Maybe an example from
past would help to--
MOHNISH PABRAI: So a business
that I didn't invest in, or--?
AUDIENCE: It could be
something you invested in,
and maybe walk us
through, here are
the three variables I
thought were most important.
MOHNISH PABRAI: Sure.
No problem.
I think that's a good question.
So a few years back, I think
this is probably going back
more than 10 years, I invested
in a funeral services company.
So you know, like
the gurus say, don't
invest in industries
of rapid change.
Humans are very slow to change
the way we deal with our dead.
It takes a few centuries
for that to change.
There's a small trend
towards cremations,
which you can kind
of adjust for,
but by and large, it's a
pretty steady situation
with cremations.
So there were these
two companies.
They had done a major roll up of
the funeral services companies.
One was Stewart Enterprises,
which is based in Louisiana.
And the other was Service
Corp. And what they had done
is they had bought
a whole bunch of mom
and pop funeral
service operators.
And a lot of it was bought
with debt, and some of it
with stock.
And so what ended up
happening is these companies
were very highly levered.
And then they got
so levered that they
started tripping confidence
on their bank debt and such.
And when I looked
at the companies--
I think when I looked
at Stewart enterprises,
it was trading at a little
less than $2 a share.
And the cash flows
it was generating
at the time were
close to $1 a share.
And it was fairly tight in terms
of their servicing the debt
and all of that,
but they were still
generating positive cash flow.
But they had lots
of assets which
were not generating any cash.
And they paid significant
amounts for it.
For example, they had bought
hundreds of funeral homes
in Europe.
And collectively, they were
making no money on those,
and such.
So I thought that a
business like that, trading
at two times cash
flows, was ultra cheap.
Because I said, you
know, what I'll do
is I'll just wait for two years.
And then, the amount we're
paying for the business
will just be there in cash.
And what they started
doing after we'd made
the investment is
they announced a sale
of a large portion of
the European businesses.
Which again, was
[INAUDIBLE] had no impact.
But they generated significant
cash from that sale.
And then, they gradually
were able to start
to restructure some of
their loans, and interest
rates, and covenants,
and all of that.
And in a few years, that
stock was at about $8 a share.
So that's an example of
looking at something.
Another one I'd
looked at-- there
was a steel company
called IPSCO.
And IPSCO had these long
contracts to supply steel.
And if you looked at the present
cash flows and the cash flow
for the next two
years-- so I think
they were trading at
about $90 a share.
They had about $30
a share in cash.
And the next two years of
cash flows were equal to $60.
And so, if you just
held it for two years,
you would have the
full $90 in cash,
but you'd have the
entire business.
And it was really hard to
tell after two years what
would happen to
margins and cash flows.
There's high uncertainty
on that front,
but I really didn't
care about that.
Because I said, we'll just
hold it for two years.
And of course, we
got to two years.
They actually got
the $90 in cash,
and then they still
had the engine running.
And I think we made a 4x on
that investment eventually.
So there's different models
and such that you can look at.
But I would say that the
most important thing is,
before you invest, you
should be able to explain
the pieces without
a spreadsheet,
within four or five sentences.
And typically, I write
down those sentences
before I invest.
So if you're having a
conversation with someone,
you could very quickly
explain, look, here's
the reasons why this
investment makes sense.
AUDIENCE: What are the
top five attributes
of a successful investor
that you think are?
And second, unrelated
question is that,
does your investment
style change
when you have control
over a company,
versus you're just
another stakeholder?
And how that changes, and how
is that important for investment
point of view?
MOHNISH PABRAI: OK.
Well, we'll see if
we can get to five.
Well I would say good
traits, or important traits,
for being a good investor.
Number 1, the single most
important skill is patience.
So I think the thing
is that markets
have kind of a way
of deceiving us.
Because when you turn on CNBC,
and you see all those flashing
red and green
lights, and all that,
it's inducing the brain to
think that you need to act now.
And you need to act immediately,
when nothing could be further
from the truth.
Buffet always talks about
having this punch card.
In a lifetime, you
make 20 punches.
And each time, you buy a
stock, you punch it once.
So in a lifetime, you'd make
20 investment decisions.
Which means that, if you
started investing at 20,
and ended at 80.
every three years, on average,
you'd make one investment.
And that is very hard
for most people to do.
And so the more you can
slow down your investing,
and the more
patient you can be--
so the issue is that the time
scales over which companies
go through change and such is
very different from the time
scale with which
stock markets operate.
So you really have to not focus
so much on the stock market,
and have a lot more focus on the
nature of change in businesses,
and be willing to be
in there for awhile.
And like I told you, for
the compounding to work,
you don't need to double your
money every three months.
Even if you double your
money every three years,
or even every five
years, that's plenty.
Because it's just a
matter of how many doubles
you can get and such.
So patience is the
number 1 skill set.
The second, I think,
important skill
would be that if you have
run a business before,
it's a huge advantage.
Because of the whole interplay
between investing and running
a business.
Because it's very important
to be able to understand how
a CEO thinks, and the factors
are there primarily focused
on thinking about, when
they're running the business.
And that's hard to get to
with spreadsheets and so on.
And I think another
very important trait
for successful
investing is to stay
within your circle
of competence.
So I think Buffett
always says that it's not
the size of the
circle that matters,
but knowing its boundaries.
It's absolutely critical.
And Charlie Munger
talks about that.
He gives a couple examples.
One is, he says that
if in a small town
you bought the
McDonald's franchise,
you bought the Ford
dealership-- Ford dealership.
Gas station not so good.
And gas station we
leave for the Patels.
Low cost operations.
OK?
And then you want the best
class of office building,
and you want the best
residential building.
Right?
So if you've got these
four assets-- and you
don't need to own
them completely.
You would own 20%
of each of them.
Right?
So his perspective was
that if in Peoria Illinois
you own these four
assets, and you just
sat on them for
your whole life, you
would end up probably
quite wealthy.
And so you think about it from a
modern portfolio point of view,
you would say, well,
you're not diversified.
Everything's in one geography,
et cetera, et cetera.
Yeah, but the odds are it'd
probably still work out.
And in fact, he has a
friend here near Stanford,
John Arrillaga, who-- all he
did was bought real estate
within a mile of
the Stanford campus.
And I think Arrillaga
is a billionaire.
And so what is Arrillaga's
circle of competence?
You know, it's this small.
So the size of the
circle is not relevant.
Staying inside the circle
is very fundamental.
So I think circle of competence
is a very important trait.
Another important trait
is margin of safety.
So you buy things for less
than what they are worth.
And then I think the final piece
would be what Ben Graham says.
That you're not buying
a piece of paper,
you're buying a
fraction of a business.
So if I were to think
about investing in Google,
for example, the question
I should ask myself is,
if my family had a
trillion dollars,
would I be happy
putting $410 billion--
is that what the market
cap is right now?
$410 billion?
Right.
So if I gave a trillion
dollars, would I be comfortable
putting $410
billion into Google?
And if the answer is no, then I
shouldn't put $10 into Google.
Right?
So many times when people say,
what do you think of Apple?
And they don't know the
market cap of Apple.
So my question is, then why are
you talking to me about Apple?
You don't even know what
the company is for sale for.
So if you're going to
invest, at a minimum,
you've got to know what the
entire business is selling for.
And would you be willing
to put 50%, 60% percent
of your total family assets,
if you had that much,
into that business?
And if the answer is
no, then don't go there.
And I would have been willing to
do that at Stewart Enterprises.
At the pricing I was
looking at and all that.
In fact, what I
would have done, I
would have bought a whole
bunch of the debt as well,
just to get total control
over the situation.
And then, you know, just
sit on those cemeteries.
They'll be fine.
Your second question was?
AUDIENCE: If you
look [INAUDIBLE]?
MOHNISH PABRAI: Yeah.
So control is overrated.
So people tend to think
that when they have control,
they can sprinkle pixie dust,
and things will be great.
And quite frankly, I don't
think that's the case at all.
I think that there are
businesses like Amex,
or Coca Cola, or
Google, and so on,
which are such high-quality
businesses that it's not
so much the control
issue, it's more
an issue of did you
enter the right price.
And those sorts of things
that matter a lot more.
AUDIENCE: But if you
talk about the passion,
about what you are
doing right here.
Like I think Warren
Buffet doesn't really
care about money.
He loves what he's doing, right?
Do think that's
what you are doing?
Do you love what you're doing?
And do you think that's
really, really important?
And do you think this
may become an obsession?
Like from reading
"The Snowball" I
have the impression
that investing
become an obstacle of
Warren Buffet's family life.
Right?
How do you adjust that?
MOHNISH PABRAI: Right.
I would say that my
take is that Buffet
is a very aligned
individual, in the sense
that he's absolutely
pursuing what he loves to do.
He would be bored
out of his mind
if you sent him fishing forever,
or sent him golfing, or just
asked him to do all
these other things which
he has no interest in doing.
So I think that he loves
the game of investing.
He loves more than investing.
He loves actually buying
entire businesses.
So he's absolutely
aligned on that front.
The thing is, you can, I think,
optimize on some variables.
So if you look at a person
like Gandhi-- Gandhi's son
became a male prostitute.
OK?
And in fact, Gandhi
neglected his kids.
So there could be
an entire debate
we could have on whether
Gandhi had done the right thing
or done the wrong
thing, with that.
So to some extent, I think the
thing is that we are human.
And it may well be that
a person like Gandhi
could not have optimized
on both fronts.
You have the same issue
with Nelson Mandela.
So if you look at Nelson
Mandela's personal life,
there's all kinds of issues
going on with the spouse,
and so on.
And in Buffett's personal
life, you had-- in fact,
I always tell my
wife that Warren
was given a mistress
by his wife.
And I tell my wife that,
so that she's aware
that that's an option.
And so far she's not pulled
the trigger on that option.
But there's still time.
And so my take is that,
I think that there
are many good traits on Warren
Buffett that have nothing
to investing.
I actually admire
the way he even
raised his kids, and so on.
But I think that what we
are probably best off doing
when we look at these
kind of iconic figures
is not focus on so
much the minutia,
because you're
going to find things
in the closet that will
make your skin crawl.
But I think look at
the bigger picture
and say, what can we take
from there that can be useful?
AUDIENCE: So I notice
that you haven't
talked about the
importance of the catalyst.
I mean the catalyst
for the correction
of the under-valuation of
financial assets such as stock.
Neither does Warren Buffett
or Munger talk a lot about it.
But some other value investors,
like maybe [INAUDIBLE], they
insist that catalyst is
very important for bet
on the value of stock.
For example, I sometimes
experience buying a stock
at a very role valuation, maybe
below the liquidation value.
And maybe just several
times of the cash flow.
But without a
catalyst, the stock
could remain undervalued,
and maybe go down.
And I just want to know
your understanding--
your suggestions regarding
situations like this.
What do you think about the
importance of the catalyst?
MOHNISH PABRAI: For the
most part, you're right.
I have ignored the
importance of a catalyst.
I think catalysts
are not required.
In most cases, value
is its own catalyst.
And I would also say that
when you're buying businesses,
let's say below liquidation
value, for example, in my book,
there's no such thing
as a value trap.
I think there are mistakes in
investing, but not value traps.
So in the end, everything
is fairly valued.
And so, to the extent
that you end up
with a less than satisfactory
return on investment,
it probably has less to do with
whether the catalyst is there
or not, and more to do
it with just the nuances
of intrinsic value
of that business.
So I have actually
found, in many cases,
that-- in fact, the
catalyst actually
flies in the face
of uncertainty.
Because if you have a catalyst,
you don't have uncertainty.
And just the nature of
the type of investor I am,
I prefer to buy low
risk high uncertainty,
and let the catalyst
work itself out.
And it has, for the most part.
I would say that form
'94-- which is what?
Five years before I started
my fund, until 2013--
before fees and all that-- it's
been a little over 26% a year.
And that engine has
not needed catalysts.
But there's more than
one way to skin the cat.
And the Seth Klarman
format of investing,
even though it's
value investing,
because value investing
is a very big tent,
is very different from the
Buffet method of investing.
One simple difference is Baupost
has more than 100 investment
professionals, and at
Berkshire there's one.
You might say one and
a half, with Charlie.
But that's it.
So I think there are many
different ways to skin the cat.
A set approach certainly
has worked for a long time.
But my personal
preference and approach
is to not bother with catalysts.
AUDIENCE: Hi.
I have a two part question.
The first is, we had a speaker
last week-- Michael Mauboussin.
He talked about
untangling skill and luck
in business and investing.
And I thought it was
very interesting.
He gave the example
of Bill Gates,
and how his mother
knew someone at IBM,
and that was part of
the reason that he
was introduced to
that opportunity.
Would you care to
comment on that?
MOHNISH PABRAI: Yeah.
But I think that there's
a lot of other people
whose mothers know
all kinds of people.
[LAUGHTER]
Well I would say, yeah,
I would say with Bill--
so if you also look at the
book "Outliers", for example.
You know, he talked about the
10,000 hours and all of that.
So Bill Gates-- a large part
of the success of Bill Gates
was when he was born.
So if Bill Gates were born
10 years before, or 10 years
after, it wouldn't have
mattered who his mother knew.
So I would say that timing
and such was definitely
gave him tailwinds, very
significant tailwinds.
But I would also say that the
Bill Gates, and the Larrys
and the Sergeys of
the world, would
tend to do well, even in
the face of headwinds.
They would not do as well
as well as they have done.
Because to do as
well as they've done,
everything has to
line up perfectly.
But I would still
say that you could
throw Bill Gates
in the fish tank
with a whole bunch of other
folks, and he'd come out ahead.
AUDIENCE: The second
part of my question
is, I recently saw a program
about the Salton Sea, which
was a very popular
tourist area in Southern
California in the '50s and '60s.
And there was huge
investment in that area
and what seemed to be very
little chance for loss.
And then there was a flood of
1976 which decimated the area,
and it never recovered.
I'd like to get your
comments on that.
Because, for example, if you
bought motels in that area,
it would have been a total loss.
MOHNISH PABRAI: That's
right, you know.
Like I said, I think
the thing with investing
is there are no absolutes.
So you're trying to
make, what I would say,
a high probability bet.
And certainly, if you
are a Patel who's just
left Uganda, with Idi Amin
breathing down your neck,
and all you can do is
buy one motel, then--
and that's the nature
of most business owners.
Is in certain times
of their career,
they will have extreme
concentration risk.
And it's pretty normal.
I mean, we have so
many bankruptcies
that happen in the
US all the time.
And many of those
are not their fault.
They just happened to be just
in the dead center of a tornado.
And so you get hit.
So it's this just the
nature of the beast.
So the good news you have
as a passive investor,
is you can spread it out a bit.
So I would say,
don't buy 40 stocks.
But you could buy
four, or three.
And even if you bought three
stocks after researching them
properly, the biggest
asset you have
is yourself, and your
ability to work at Google,
and produce cash
flows, and so on.
So you have another
ace in the hole,
if you have that
sort of situation.
So I think in your
particular circumstance,
you don't need to
go all in one place.
AUDIENCE: You talked about
the value investing tent.
And you also talked
about 20 punches.
And if my understanding
is correct,
then the 20 punches naturally
causes Warren Buffett style
of investing to look for
compounding machines.
Because you have limited
time in your lifetime
when you're going to identify
compounding machines.
And in those times, he
has been willing to pay
what traditionally may
not sound like value.
For example, he paid like 28
times earnings on Moody's.
And he paid 25 times on Coke.
And there's obviously
the other extreme,
of like the Ben Graham.
Where exactly do you fall in?
And have you felt the
urge, or the need,
to say over your past career,
that I need to change my tent
and move slightly
here, slightly there.
What has been some
of the [INAUDIBLE]?
MOHNISH PABRAI: Right.
Yeah, that's a great question.
The best possible business
you could invest in
is a great business that's
growing at a nice clip,
and that has high
returns on capital,
and one that can absorb
the capital it produces.
That would be the gold standard.
And probably Google gets
the closest to that.
I would say even a
business like Coke or Amex,
the problem is they're very
good businesses-- yeah,
they're not able to consume
the cash they put forth.
So those types of businesses,
which are compounding machines,
which are able to
absorb capital,
tend to be few and
far between, and tend
to be ridiculously
overpriced, typically.
Or at least on perception
bases, they're overpriced.
So if you can't find that,
then you go to plan B.
And Buffett has done,
even now he continues
to do, plenty of plan
B type investing.
So for example, he bought the
debt of a specialty finance
company called FINOVA which
was basically just mispriced,
and they were just looking
for that whole thing to being
run off, and they would
make a return on it.
But it's nothing
like Coke or Amex.
So I would say, first
plan, compounding machines.
You can't get that,
then you go to plan
B, which is undervalued
assets, and so on.
I have learned,
probably the hard way,
that it's better to
put as much as you can
on the great businesses
with great managers.
Even if you pay up a little bit.
But you know, old
habits die hard.
We still like to have that
hunt for the extremely cheap
business as well.
And so it's a mix.
I would say that it's a mix.
And it just depends
on-- I'm flexible.
I think it's very
important in investing
to be a learning machine, and
to have flexibility, and to be
willing to look at
the opportunity set.
And decide whether you
need to do anything at all,
or what is the
best thing you can
do based on the
available opportunities?
And then take it from there.
So sometimes it can just be one
of these mispriced bets that
plays out in two or three years.
And maybe that can go into
a compounding machine,
and so, and so on.
Flexibility is a good
trait, but it's always
good to get into those
compounding machines.
I think those are
the holy grail.
MALE SPEAKER: So
with that, let's all
thank Mohnish very
much for the talk.
[APPLAUSE]
