Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with management of the highest integrity and ability. Then you own those shares forever. I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.

November 28, 2010

保险公司的内含价值 93.45元对应的内含率是:2.97倍

http://www.ltkdj.com/bbs/viewthread.php?tid=39685&extra=page=1
“保险公司的内含价值”是内地投资者近些年才刚开始关注不久的指标,换句话说,净资产、净利润并不是保险股估值的最好指标。
  王小罡指出,保险公司(主要指寿险公司)的内含价值(EV)相当于其他行业公司的净资产,保险公司的内含价值收益(即内含价值的实际增长,或EVE,EV Earning)则相当于其他行业公司的净利润。因此,保险公司的实际市净率为P/EV,实际市盈率为P/EVE,实际净资产收益率为EVE/EV。
  李双武表示,市场经常只看一个公司的市盈率、市净率,而这不是判断保险股是否具有投资价值的主要因素。保险公司的特点是看其内含价值,比如说太保,按12%的折现率,意味着中国太保的净资产,每年是按12%的内含价值增速往上涨的,也就是说在内含价值以下买中国太保,内含价值每年都会有12%的增长。
  以市盈率来看,国寿、平安最近分别为50倍、46倍,太保则高达138倍。王小罡指出,从内含价值的角度看,2009年平安的内含价值为20元/股,国寿和太保均在11元/股左右;而从内含价值收益角度看,国寿、平安、太保分别为1.56元/股、4.01元/股、1.51元/股。由此得出国寿、平安、太保的实际市盈率(P/EVE)分别为19.1倍、12.9倍、16.7倍。
  王小罡表示,从这些数字可以看到,三大保险股的估值都比较低,特别是平安,2009年不到13倍,2010年预测值不到11倍。A股市场上平安现在每股50多块钱,对比其他两家保险公司,性价比更高、成长性也较好的平安其实已经相当便宜,很适合长期持有。
  在王小罡看来,三大保险股H股股价高于A股的现象在2010年还会持续,而且将来会持续多长时间,并不好判断。
  李双武表示,投资者在A股还是在H股投资保险股其实差别并不大,不过从目前来看,A股更便宜些。如果是一个长期投资者的话,当保险股的股价在内含价值以下时,应该买入,如果某一时间,保险股被炒作,价格远远超过内含价值,就应该卖掉,这是保险市场特有的。
  在三只保险股中,大多数分析师更看好估值相对较低的平安。海通证券(9.67,-0.12,-1.23%)特别看好平安,认为A股估值水平显著低于H股,具备较好安全边际;申银万国也建议投资保险股,应首选配置中国平安。
09年平安内含价值是21.1元
10年中平安内含价值是24.1元
预计10年平安内含价值:26.5元
按50元市价,10年市盈率才:50/(26.5-21)=9.1
太记住以后买保险股,价格在内含价值2、3倍,可以买进。4倍内含价值可以忍受,但5、6倍时考虑卖出。
低估了
港股的00945,宏利金融。2000年3月80元,到2006年5月是580元,还不计分红。宏利金融只是加拿大保险股,人口老化啊。
港股调整主要是AIA保险招股,最多1600亿港元,国外投资者配置保险股会调仓。但股价最终还是跟内含价值和新业务价值走,看好平安2019年股价在500-1200元,极端到2000元/股
三季净资产14.52
三季净资产增长14.52-13.75+0.45=1.22,不算太差,但也没超预期
分析一下正常经营净资产增长情况:09年11.57,10年1季:12.21,10年2季:13.75(扣换股增发实际12.6),10年3季:14.52
一季度增长:0.64
二季度增长:0.39
三季度增长:1.22
上面数字没考虑换股增发增厚,但考虑分红影响
再看内含价值增长:
正常经营:上半年内含价值增长:24.1-21.1-1.15=1.85元,其中净资产增长1.03,业务价值增长1.85-1.03=0.82,假设下半年也是0.82元。
假设四季度净资产也增长1.22元,刚全年内含价值增长:24.1+1.22*2+0.82=27.36。
留待以假设今年上证收在3000点,四季增长和三季差不多,粗算净资产4季也增加1.22元
正常经营全年净资产0.64+0.39+1.22+1.22-0.45=3.47,
年报净资产:11.57+3.47+1.15=16.17
内含价值:27.36
留待年报验证
后验证
09年净资产是11.57  10年16.17,增加39.7%
09年内含价值21.1    10年27.36,增加29.6%
净资产和内含价值有收购深发展增厚的1.15元,这不是可持续性的。所以年报净资产和内含价值增加超预期
当然我也估算平安2010年合理价格
数据:2009年内含价值21.1,寿险内含价值:13.71,一年新业务价值:1.61
2010年中报内含价值24.1,寿险内含价值:14.91,一年新业务价值:1.19
因保险业上半年保费比下半年高,但股市下半年比下半年好,假设寿险内含价值增长同上半年一样,一年新业务价值全年增长36%
则2010年报:内含价值27.36,寿险内含价值:17.30,一年新业务价值:2.19
1、寿险按25-35倍新业务价值,其它银行、财险、集团按15元/股,股价在87.05-108.95
2、按内含价值2.7-3.5倍:股价在73.87-95.76
平安稳含的利好:房地产投资价值重估,PE投资项目和深发展交叉销售贡献,但都要5-10较长时间体现。其中房产和PE靠以前累积的项目,大幅领先同行,相信过几年后,投行再给平安估值时,会提到上面,然后再给平安比同行更高的溢价8月末,A股市场的三大保险业巨头相继交出半年期成绩,在当前低迷的资本市场面前,保险股消费属性的重要性进一步凸显。三大保险公司在衡量新业务发展方面的重要指标一年期新业务价值的表现上迥然不同。  新业务价值是衡量保险公司业务长期可持续性增长的一个重要指标,是指在报告期间销售的新保单在签单时的价值。包括新业务预期续保和预期合同变动的价值。计算新业务价值时,应当考虑持有要求资本的成本。银河证券分析师许力平指出,保单缴费方式、缴费期限以及销售渠道都会影响保险公司新业务价值,期缴产品比趸缴产品对新业务价值贡献更大,营销渠道要比银保渠道销售的保单新业务价值更高,保单缴费期限延长也会增加新业务价值。  A  平安 迅猛增长44%  平安的新业务表现相当抢眼,一串漂亮的数字超出不少机构预期,使得多家分析机构对平安的前景看好。首年保费增长52.1%,一年新业务价值增速高达44%,华泰证券分析,平安证券全年的一年新业务价值至少要达到30%的增速。快速增长的新业务促成平安上半年规模保费收入达到931.25亿元,同比增长25.98%。银河证券分析师许力平认为,“平安在最近几年扩张速度非常快,主要压力还是来源于过去积累的一些高利率保单,必须依赖新保单收入来消化。”除此之外,寿险市场第二梯队泰康、新华的步步追赶也促使平安发力增加保费收入。  平安一年新业务价值增速远远超过规模保费增速说明平安新业务的开拓是“质”“量”双优。质的提高来自于业务结构的优化。从渠道看,利润率较高的个人业务渠道占比提高5.8%,占比达到78.8%。个险规模保费增长35.9%,催化一年新业务价值迅速增长。从缴费期限看,去年以趸缴保费贡献为主,而今年上半年期缴业务占比有了明显上升。从产品结构上,分红险取代万能险成为主打险种。除了结构上的优化以外,平安的销售能力提高也是促成新业务价值增长的重要因素,最显著的表现是件均保费提高,人均产能提高。  B  太保 稳步提升18%  中国太保继续稳步提升的趋势,一年新业务价值增长18%,表现也不俗。在新业务的推动下,上半年太保寿险总保费收入同比增长超过50%。尤其是分红险,增长速度最快,同比增速达到73%。不过也有市场相关分析人士认为,相对于新保保费53%的增速,太保一年新业务价值的增速差强人意。对此,许力平认为,“主要原因是依赖银保业务,银行业务中很多是趸缴产品,趸缴产品在为公司创造长期性的业务收入方面表现逊色很多。”据记者资料统计,上半年太保银保渠道增速高达92%,营销渠道的增速只有19%。营销渠道业务占比从2009年的将近五成下降到今年上半年的38%。除了渠道结构不合理外,缴费期限也呈现短期化趋势,缴费10年及以上的传统和分红型新保业务收入相比上年下降18.4%,中短期趸缴分红产品的比重上升。  C  国寿 调整中增长10.9%  中国人寿的一年期新业务价值增长较为缓慢,同比增长仅10.9%,低于行业平均水平。首年保费收入增长仅9.4%,这也导致中国人寿的市场份额出现一定下滑。  虽然中小保险公司尤其是寿险市场第二梯队的崛起给寿险巨头带来了冲击,但是银河证券分析师许力平指出,“中国人寿新业务价值增长缓慢主要还是受业务结构调整的影响。2008年以来保监会要求调整保险公司的业务结构,注重长期可持续性发展,中国人寿的调整力度是最大的。但是中国人寿的调整节奏有些缓慢,导致新业务保费收入增长缓慢。”  在资本市场表现糟糕的情况下,新业务带来的利润就成为挽救公司净资产下降的救命稻草,在如此缓慢的保费增长状况下,国寿上半年归属于股东的每股净资产比2009年年末下降了9.2%。  尽管中国人寿业务结构调整比较缓慢,但也取得一定成绩,突出的表现就是新业务价值增长速度超过首年保费增速。国寿的业务结构也的确朝更均衡、合理的方向发展:保单期限延长,10年期及以上首年期缴保费的比重达到27%,期缴率提高,首年期缴保费占新保保费的比重有所上升。  不过, 许力平指出,只有在公司经营持续稳定的情况下,新业务价值预期未来才可以为保险公司带来利润,但在短期内,新业务价值越高,并不意味着公司利润越高。平安2010年报预测和估值
先看内含价值增长:
正常经营:上半年内含价值增长:24.1-21.1-1.15=1.85元,其中净资产增长1.03,业务价值增长1.85-1.03=0.82,假设下半年也是0.82元。
假设四季度净资产也增长1.22元,刚全年内含价值增长:24.1+1.22*2+0.82=27.36。
再看净资产增长
假设今年上证收在3000点,四季增长和三季差不多,粗算净资产4季也增加1.22元
正常经营全年净资产0.64+0.39+1.22+1.22-0.45=3.47,
年报净资产:11.57+3.47+1.15=16.17
09年净资产是11.57  10年16.17,增加39.7%
09年内含价值21.1    10年27.36,增加29.6%
当然净资产和内含价值有收购深发展增厚的1.15元,这不是可持续性的。所以年报净资产和内含价值增加超预期
我也估算平安2010年合理价格
数据:2009年内含价值21.1,寿险内含价值:13.71,一年新业务价值:1.61
2010年中报内含价值24.1,寿险内含价值:14.91,一年新业务价值:1.19
因保险业上半年保费比下半年高,但股市下半年比下半年好,假设寿险内含价值增长同上半年一样,一年新业务价值全年增长36%
则2010年报:内含价值27.36,寿险内含价值:17.30,一年新业务价值:2.19
1、寿险按25-35倍新业务价值,其它银行、财险、集团按15元/股,股价在87.05-108.95
2、按内含价值2.7-3.5倍:股价在73.87-95.76
25-35倍是新业价值倍数,不是PE,这是保险业一种估值参数,这个参数定的很复杂,但一种最方便是新业务价值增长数相当倍数
正常经营全年净资产0.64+0.39+1.22+1.22-0.45=3.47,
年报净资产:11.57+3.47+1.15=16.17
原来这里算错,应该是
正常经营全年净资产0.64+0.39+1.22+1.22-0.45=3.02
年报净资产:11.57+3.02+1.15=15.74
09年净资产是11.57  10年15.74,增加36.0%
09年内含价值21.1    10年27.36,增加29.6%
07、08年内含价值估算在20-22,没有42这么高,当时股价是内含价值的5倍以上,确实可以考虑卖出
还是那句话,保险股,价格在内含价值2、3倍,可以买进。4倍内含价值可以忍受,但5、6倍时考虑卖出
合理估值=每股内含价值+每股一年新业务价值*新业务倍数。
这个是寿险的估值,平安还有财险、银行、投资、集团业务
寿险内含价值:17.30,一年新业务价值:2.19
按25-35倍新业务价值,其它银行、财险、集团按15元/股,股价在87.05-108.95
但这新业务倍数太难选,低时10倍,高时50倍都有,但按平安这两年都在35%增长,取25倍算保守,有人说增长多少就是多少倍
寿险按10、15、20、25、30、35、40、45、50倍新业务价值,其它银行、财险、集团按15元/股
股价分别为:54.2、65.15、76.1、87.05、98.0、108.95、119.9、141.8
我估计2010年很难见到10倍新业务倍数估值,既54.2元很难见到
寿险按10、15、20、25、30、35、40、45、50倍新业务价值,其它银行、财险、集团按15元/股
股价分别为:65.73、80.28、109.38、123.93、138.48、153.03、167.58、182.13
H股还在80以上。保险股的魅力在于,指数几年不动,保险公司可以靠内含价值的增长提高估值,明年平安再见到60以下有点难度,不然那新业务价值倍数在10倍以下了。发达国家保费增长才几个点,平均都在10多倍新业务价值倍数。
庄就是净资产、内含价值、新业务价值的增长速度。连业绩都不算2011.11.3 保险业:AIA与国内保险公司经营比较
AIA上市受追捧,首大涨17%投资者看好AIA亚太业务,中国溢价和低估值促使AIA受追捧。
  亚太地区保险业务发展潜力2009年亚太地区保险收入3580亿美元,占全球保险市场的15.4%,但亚太地区保险市场体现出不均衡状态,表现在高保费增长与较低的保险深度和密度,人口高增长与缺失的医疗体制,高经济增长与高储蓄率,人口老龄化与落后的养老金市场。这些都为商业保险提供了巨大的机会。
  AIA在中国大陆经营情况AIA目前只在广东江苏上海北京四地开展业务,但市场份额却占到第8位,从业务结构看,AIA主要业务来自于盈利较高的个人寿险。AIA、中国平安(60.44,-0.05,-0.08%)、中国人寿(25.63,-0.07,-0.27%)、中国太保(26.00,-0.01,-0.04%)年化后银保保费在年化总保费(年化保费=趸交保费*10%+新单期交保费)中占比分别为8%、9.6%、31%、52.5%。从业务经营和新业务价值情况看,中国平安与AIA最为接近。
  AH股风格比较A股注重市值较小成长较大的股票,而H股更多看中某类地区和行业具有垄断地位公司,因此两地上市的金融企业,H股溢价存在就不言而喻。
  投资建议和风险提示从AIA上市表现看,备受H股投资者追捧,我们继续维持现有行业买入评级。
  资本但平安这两年内含价值和新业务价值增长速度在26.5%和36%,假设以后都增长25%、30%,到2020年内含价值和新业务价值分别是:245元和28.7元。关键是平安以后十年能不能保持这个速度
友邦高速发展时股价是内含价值的3-5倍,或新业务价值20-35倍加一倍内含价值
市场波动提高内含价值还有一方法:并购,汇丰就是这样发展的会影响公司业绩。
每年下半后,评级机构都会说到平安保费放缓,有时不知道评级机构真不知,还是没做好功课。我一直在跟踪平保保费,看下表
平安保费每年一直是前高后低,特别是个险、期交的比例很高。期交意味着下一年最少还要交同样保费(没新单和退保情况下),
从表中,轻易判断平安10-12月保费收入,还要继续放缓(除非这三个月平保改变策,大量增加低价值的银保业务),明年1、2月保费又是同比、环比大增,其实都在预期之内
预计
1-10月总保费1890 
1-11月总保费2040
1-12月总保费22502011.11.1
港股平安不一样的90元
2007年9月平安H股上到90元,今天港股平安H收报93.45.
07年港币兑换人民币:100:97
今天港币兑换人民币:100:86
07年平安内含价值是20RMB
今天平安内含价值是27RMB
07年平安H股在93.45元对应的内含率是:4.53倍,A股在93.45元对应的内含率是:4.67倍
今天平安H股在93.45元对应的内含率是:2.97倍,A股在62.49元对应的内含率是:2.31倍


鉴别点 大顶特征 大底特征
估值面 2次大牛市顶部都发生在市场平均PE60之上,一次在50PE上,因此60PE是绝对的高危区 2次大底部都在市场平均PE15左右,大量的股票破发行价、增发价,破净资产。企业开始陆续出现回购,增持股票等行为。因此PE15左右是低估区。
技术面 大顶的日线基本是双头;月线特别注意第一不可跌破5月线(特别是下月依然无法收回),从此指数被5月线一路压制;第二是配合第一的指标同时,月MACD高位死叉迹象+KDJ高位死叉迹象;日线上30日线成为强压,历次反弹都难以连续站稳几天。市场演绎的是经典的盘久必跌轮回。 以月K线突破5月线为标志,且KDJ低位20左右金叉成功,此后一路依托5月线上行不得跌破确认;同时配合周线5金叉10,依托5上行,周KDJ20金叉;日线突破长期下沉趋势线压制,市场持续放量,底部盘整没有再次盘久必跌,反而是越盘越缩量并几根大阳线突破,之后每次盘整低点逐步抬高;放量突破30日线,特别是30日线开始有上拐倾向时
政策面 从对市场的支持到模糊,再到不断的提示风险,再到实质上的频频出手干预政策(如印花税提高),打压股市的态度越来越强烈和露骨 从对下跌的默许,到言论开始明确挺市,到开始局限于市场本身的干预(调印花税红利税等),到频频呼唤信心并动用资金手段(降息,发基金,停IPO等),最后到实质性的产业政策刺激(投资或者对多行业的长期利好或者股票市场的大改革等)
资金面 连续的加息、基金窗口指导、暂停新基金发行、基金仓位几乎都处于极高位、大盘股不断上市或者大额度融资 连续的降息,加大基金发行力度,力压IPO冻结,否决所有大额的融资计划,基金仓位几乎都处于合同约定的最低位
心理面 市场不断的找寻泡沫支持的理由,几乎没有机构看熊市场,一致性的看好市场的持续走好,基金和股票开户数连创新高,特别是周围从不关心股市的人开始纷纷入市 市场一开始绝不会相信牛市已经结束,其中的几次反弹都会带来新的憧憬,到开始绝望不顾一切的抛售,再到对任何利好都漠不关心且不看好,对经济前景极度绝望和恐惧
其它
配合技术面,出现前景不明的重大隐患事件,比如金融危机、严重的通胀迹象、某热点经济泡沫崩溃迹象等
另一个值得注意的,则是强周期类股票的全面溃败。
配合技术面,出现大热点板块,开始有讲故事的基础。同样,强周期类股票特别是有色等股票的反弹猛烈,也往往是市场底部形成的迹象。

November 27, 2010

Mohnish Pabrai - 2

Interview With Value Investor Mohnish Pabrai
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It is my privilege to bring you the following interview I recently conducted with value investing superstar Mohnish Pabrai. Mohnish is my favorite investor who doesn't have the initials W.B. His stock selection style is similar to mine, except that he's more successful at it. Much, much more successful.

I'll let the numbers speak for themselves: A $100,000 investment in Pabrai Funds at inception (on July 1, 1999) was worth $722,200 on March 31, 2007. That works out to an annualized return of 29.1%, and that's after all fees and expenses. Assets under management are over $500 million, up from $1 million at inception. Although a person probably can't get into the investing hall of fame with eight years of outperformance (even if they crush the indices), Pabrai is already mentioned in most articles about the search for the next Warren Buffett, and justifiably so.

Equally importantly, he genuinely wants to help others become better investors, and in that spirit has just published his second book, The Dhandho Investor. The book is both illuminating and easy to read, and it deserves to be on every investor's bookshelf next to Benjamin Graham's The Intelligent Investor. This is why I felt extremely fortunate when he recently agreed to answer some questions about his investment strategy in this exclusive interview, conducted by email. I hope you find it useful, and I hope it inspires you to pick up a copy of his book if you haven't already.

Happy Investing,

Tom Murcko
CEO, InvestorGuide.com

InvestorGuide: You have compared Pabrai Funds to the original Buffett parternships, and there are obvious similarities: investing only in companies within your circle of competence that have solid management and a competitive moat; knowing the intrinsic value now and having a confident estimate of it over the next few years, and being confident that both of these numbers are at least double the current price; and placing a very small number of very large bets where there is minimal downside risk. Are there any ways in which your approach differs from that of the early Buffett partnerships (or Benjamin Graham's approach), either because you have found ways to improve upon that strategy or because the investing world has changed since then?

Mohnish Pabrai: The similarity between Pabrai Funds and the Buffett Partnerships that I refer to is related to the structure of the partnerships. I copied Mr. Buffett's structure as much as I could since it made so much sense. The fact that it created a very enduring and deep moat wasn't bad either. These structural similarities are the fees (no management fees and 1/4 of the returns over 6% annually with high water marks), the investor base (initially mostly close friends and virtually no institutional participation), minimal discussion of portfolio holdings, annual redemptions and the promotion of looking at long term results etc. Of course, there is similarity in investment style, but as Charlie Munger says, "All intelligent investing is value investing."

My thoughts on this front are covered in more detail in Chapter 14 of The Dhandho Investor.

Regarding the investment style, Mr. Buffett is forced today to mostly be a buy and hold forever investor today due to size and corporate structure. Buying at 50 cents and selling at a dollar is likely to generate better returns than buy and hold forever. I believe both Mr. Munger and he would follow this modus operandi if they were working with a much smaller pool of capital. In his personal portfolio, even today, Mr. Buffett is not a buy and hold forever investor.

In the early days Mr. Buffett (and Benjamin Graham) focused on buying a fair business at a cheap price. Later, with Mr. Munger's influence, he changed to buying good businesses at a fair price. At Pabrai Funds, the ideal scenario is to buy a good business at a cheap price. That's very hard to always do. If we can't find enough of those, we go to buying fair businesses at cheap prices. So it has more similarity to the Buffett of the 1960s than the Buffett of 1990s. BTW, even the present day Buffett buys fair businesses at cheap prices for his personal portfolio.

Value investing is pretty straight-forward - you try to get $1 worth of assets for much less than $1. There is no way to improve on that basic truth. It's timeless.

InvestorGuide: Another possible difference between your style and Buffett's relates to the importance of moats. Your book does emphasize investing in companies that have strategic advantages which will enable them to achieve long-term profitability in the face of competition. But are moats less important if you're only expecting to hold a position for a couple years? Can you see the future clearly enough that you can identify a company whose moat may be under attack in 5 or 10 years, but be confident that that "Mr. Market" will not perceive that threat within the next few years? And how much do moats matter when you're investing in special situations? Would you pass on a special situation if it met all the other criteria on your checklist but didn't have a moat?

Pabrai: Moats are critically important. They are usually critical to the ability to generate future cash flows. Even if one invests with a time horizon of 2-3 years, the moat is quite important. The value of the business after 2-3 years is a function of the future cash it is expected to generate beyond that point. All I'm trying to do is buy a business for 1/2 (or less) than its intrinsic value 2-3 years out. In some cases intrinsic value grows dramatically over time. That's ideal. But even if intrinsic value does not change much over time, if you buy at 50 cents and sell at 90 cents in 2-3 years, the return on invested capital is very acceptable.

If you're buying and holding forever, you need very durable moats (American Express, Coca Cola, Washington Post etc.). In that case you must have increasing intrinsic values over time. Regardless of your initial intrinsic value discount, eventually your return will mirror the annualized increase/decrease in intrinsic value.

At Pabrai Funds, I've focused on 50+% discounts to intrinsic value. If I can get this in an American Express type business, that is ideal and amazing. But even if I invest in businesses where the moat is not as durable (Tesoro Petroleum, Level 3, Universal Stainless), the results are very acceptable. The key in these cases is large discounts to intrinsic value and not to think of them as buy and hold forever investments.

InvestorGuide: For that part of our readership which isn't able to invest in Pabrai Funds due to the net worth and minimum investment requirements, to what extent could they utilize your investing strategy themselves? Your approach seems feasible for retail investors, which is why I have been recommending your book to friends, colleagues, and random people I pass on the street. For example, your research primarily relies on freely available information, you aren't meeting with the company's management, and you don't have a team of analysts crunching numbers. To what extent do you think that a person with above-average intelligence who is willing to devote the necessary time would be able to use your approach to outperform the market long-term?

Pabrai: Investing is a peculiar business. The larger one gets, the worse one is likely to do. So this is a field where the individual investor has a huge leg up on the professionals and large investors. So, not only can The Dhandho Investor approach be applied by small investors, they are likely to get much better results from its application than I can get or multi-billion dollar funds can get. Temperament and passion are the key.

InvestorGuide: You founded, ran, and sold a very successful business prior to starting Pabrai Funds. Has that experience contributed to your investment success? Since that company was in the tech sector but you rarely buy tech stocks (apparently due to the rarity of moats in that sector), the benefits you may have derived seemingly aren't related to an expansion of your circle of competence. But has learning what it takes to run one specific business helped you become a better investor in all kinds of businesses, and if so, how? And have you learned anything as an investor that would make you a better CEO if you ever decide to start another company?

Pabrai: Buffett has a quote that goes something like: "Can you really explain to a fish what it's like to walk on land? One day on land is worth a thousand years of talking about it, and one day running a business has exactly the same kind of value." And of course he's said many times that he's a better investor because he's a businessman and he's a better businessman because he is an investor. My experience as an entrepreneur has been very fundamental to being any good at investing.

My dad was a quintessential entrepreneur. Over a 40-year period, he had started, grown, sold and liquidated a number of diverse businesses - everything from making a motion picture, setting up a radio station, manufacturing high end speakers, jewelry manufacturing, interior design, handyman services, real estate brokerage, insurance agency, selling magic kits by mail - the list is endless. The common theme across all his ventures was that they were all started with virtually no capital. Some got up to over 100 employees. His downfall was that he was very aggressive with growth plans and the businesses were severely undercapitalized and over-leveraged.

After my brother and I became teenagers, we served as his de facto board of directors. I remember many a meeting with him where we'd try to figure out how to juggle the very tight cash to keep the business going. And once I was 16, I'd go on sales calls with him or we'd run the business while he was traveling. I feel like I got my Harvard MBA even before I finished high school. I did not realize it then, but the experience of watching these businesses with a front-row seat during my teen years was extremely educational. It gave me the confidence to start my first business. And if I have an ability to get to the essence of a subset of businesses today, it is because of that experience.

TransTech was an IT Services/System Integration business. We provided consulting services, but did not develop any products etc. So it wasn't a tech-heavy business. While having a Computer Engineering degree and experience was useful, it wasn't critical. TransTech taught me a lot about business and that experience is invaluable in running Pabrai Funds. Investing in technology is easy to pass on because it is a Buffett edict not to invest in rapidly changing industries. Change is the enemy of the investor.

Being an investor is vastly easier than being a CEO. I've made the no-brainer decision to take the easy road! I do run a business even today. There are operating business elements of running a fund that resemble running a small business. But if I were to go back to running a business with dozens of employees, I think I'd be better at it than I was before the investing experience. Both investing and running a business are two sides of the same coin. They are joined at the hip and having experience doing both is fundamental to being a good investor. There are many successful investors who have never run a business before. My hat's off to them. - For me, without the business experiences as a teenager and the experience running TransTech, I think I'd have been a below average investor. I don't fully understand how they do it.

InvestorGuide: Is your investment strategy the best one for you, or the best one for many/most/all investors? Who should or shouldn't consider using your approach, and what does that decision depend on (time commitment, natural talent, analytical ability, business savvy, personality, etc)?

Pabrai: As I mentioned earlier, Charlie Munger says all intelligent investing is value investing. The term value investing is redundant. There is just one way to invest - buy assets for less than they are worth and sell them at full price. It is not "my approach." I lifted it from Graham, Munger and Buffett. Beyond that, one should stick to one's circle competence, read a lot and be very patient.

InvestorGuide: Some investment strategies stop working as soon as they become sufficiently popular. Do you think this would happen if everyone who reads The Dhandho Investor starts following your strategy? As I've monitored successful value investors I have noticed the same stocks appearing in their various portfolios surprisingly often. (As just one example, you beat Buffett to the convertible bonds of Level 3 Communications back in 2002, which I don't think was merely a coincidence.) If thousands of people start following your approach (using the same types of screens to identify promising candidates and then using the same types of filters to whittle down the list), might they end up with just slightly different subsets of the same couple dozen stocks? If so, that could quickly drive up the prices of those companies (especially on small caps, which seem to be your sweet spot) and eliminate the opportunities almost as soon as they arise. Looked at another way, your portfolio typically has about ten companies, which presumably you consider the ten best investments; if you weren't able to invest in those companies, are there another 10 (or 20, or 50) that you like almost as much?

Pabrai: As long as humans vacillate between fear and greed, there will be mispriced assets. Some will be priced too low and some will be priced too high. Mr. Buffett has been talking up the virtues of value investing for 50+ years and it has made very few folks adopt that approach. So if the #2 guy on the Forbes 400 has openly shared his secret sauce of how he got there for all these decades and his approach is still the exception in the industry, I don't believe I'll have any effect whatsoever.

Take the example of Petrochina. The stock went up some 8% after Buffett's stake was disclosed. One could have easily bought boat loads of Petrochina stock at that 8% premium to Buffett's last known buys. Well, since then Petrochina is up some eight-fold - excluding some very significant dividends. The entire planet could have done that trade. Yet very very few did. I read a study a few years back where some university professor had documented returns one would have made owning what Buffett did - buying and selling right after his trades were public knowledge. One would have trounced the S&P 500 just doing that. I don't know of any investors who religiously follow that compelling approach.

So, I'm not too concerned about value investing suddenly becoming hard to practice because there is one more book on a subject where scores of excellent books have already been written.

InvestorGuide: You have said that investors in Pabrai Funds shouldn't expect that your future performance will approach your past performance, and that it's more likely that you'll outperform the indices by a much smaller margin. Do you say this out of humility and a desire to underpromise and overdeliver, or is it based on market conditions (e.g. thinking that stocks in general are expensive now or that the market is more efficient now and there are fewer screaming bargains)? To argue the other side, I can think of at least two factors that might give your investors reason for optimism rather than pessimism: first, your growing circle of competence, which presumably is making you a better investor with each passing year; and second, your growing network of CEOs and entrepreneurs who can quickly give you firsthand information about the real state of a specific industry.

Pabrai: Future performance of Pabrai Funds is a function of future investments. I have no idea what these future investment ideas would be and thus one has to be cognizant of this reality. It would be foolhardy to set expectations based on the past. We do need to set some benchmarks and goals to be measured against. If a fund beats the Dow, S&P and Nasdaq by a small percentage over the long-haul they are likely to be in the very top echelons of money managers. So, while they may appear modest relative to the past, they are not easy goals for active managers to achieve.

The goals are independent of market conditions today versus the past. While circle of competence and knowledge does (hopefully) grow over time, it is hard to quantify that benefit in the context of our performance goals.

InvestorGuide: Finally, what advice do you have for anyone just getting started in investing, who dreams of replicating your performance? What should be on their "to do" list?

Pabrai: I started with studying Buffett. Then I added Munger, Templeton, Ruane, Whitman, Cates/Hawkins, Berkowitz etc. Best to study the philosophy of the various master value investors and their various specific investments. Then apply that approach with your own money and investment ideas and go from there.

------------------------
Buffett Succeeds at Nothing

http://www.fool.com/portfolios/rulemaker/2002/rulemaker021030.htm

By Mohnish Pabrai
10/30/2002

Editor's Note: Occasionally, we like to feature articles from readers in this space. Mohnish Pabrai, the managing partner of Pabrai Investment Funds and mpabrai on the Fool discussion boards, offers his view on the difficulty investors have -- professional and individual alike -- in just sitting still.

Seventeenth century French scientist Blaise Pascal is perhaps best remembered for his contributions to the field of pure geometry. In the 39 years that he lived, he found time to invent such modern day fundamentals as the syringe, the hydraulic press, and the first digital calculator. And, if that weren't enough, he was also a profound philosopher. One of my favorite Pascal quotes is: "All man's miseries derive from not being able to sit quietly in a room alone."

I've often thought that Pascal's words, slightly adapted, might apply well to a relatively new subset of humanity: "All portfolio managers' miseries derive from not being able to sit quietly in a room alone."

Why should portfolio managers sit and do nothing? And why would that be good for them? Well, let's start with the story of D.E. Shaw & Co. Founded in 1988, Shaw was staffed by some of the brightest mathematicians, computer scientists, and bond trading experts on the planet. Jeff Bezos worked at Shaw before embarking on his Amazon.com(Nasdaq: AMZN) journey. These folks found that there was a lot of money to be made with risk-free arbitrage in the bond markets with some highly sophisticated bond arbitrage trading algorithms.

Shaw was able to capitalize on minuscule short-term inefficiencies in the bond markets with highly leveraged capital. The annualized returns were nothing short of spectacular -- and all of it risk-free! The bright folks at Shaw put their trading on autopilot, with minimal human tweaking required. They came to work and mostly played pool or video games or just goofed off. Shaw's profit per employee was astronomical, and everyone was happy with this Utopian arrangement.

Eventually, the nerds got fidgety -- they wanted to do something. They felt that they had only scratched the surface and, if they only dug deeper, there would be more gold to be mined. And so they fiddled with the system to try to juice returns.

What followed was a similar path taken by Long-Term Capital Management (LTCM), a fund once considered so big and so smart on Wall Street that it simply could not fail. And yet, when economic events that did not conform to its historical model took place in rapid succession, it nearly did just that. There was a gradual movement from pure risk-free arbitrage to playing the risky arbitrage game in the equity markets. A lot more capital could be deployed, and the returns looked appealing. With no guaranteed short-term convergence and highly leveraged positions, the eventual result was a blow-up that nearly wiped out the firm.

Compared to nearly any other discipline, I find that fund management is, in many respects, a bizarre field --where hard work and intellect don't necessarily lead to satisfactory results. As Warren Buffett succinctly put it during the 1998 Berkshire Hathaway(NYSE: BRK.A) annual meeting: "We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely!"

Buffett and his business partner Charlie Munger are easily among the smartest folks I've come across. But, as we've seen with Shaw and LTCM, a high I.Q. may not lead to stellar investing results. After all, LTCM's founders had among them Nobel Prize-winning economists. In the long-run, it didn't do them much good. In fact, they outsmarted themselves. In a 1999 interview with BusinessWeek, Buffett stated:

Success in investing doesn't correlate with IQ -- once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Events at Shaw and LTCM show that high-IQ folks have a hard time sitting around contemplating their navels. The problem is that once you engage in these intellectually stimulating problems, you're almost guaranteed to find what you think are the correct answers and act upon them -- usually leading to bad results for investors.

Having observed Buffett and Munger closely over the years, and gotten into their psyche through their speeches and writings, it is clear to me that, like the folks at Shaw and LTCM, both men need enormous doses of intellectual stimulation as part of their daily diet. How do they satisfy this intellectual hunger without the accompanying actions that get investors into trouble?

Consider the following:

While Buffett plays bridge (typically 10-20 hours per week), Munger spends his time mostly on expanding his worldly wisdom and constantly improving his latticework of mental models. He is a voracious reader of intellectually engaging books on a variety of subjects, ranging from the various Ice Ages to The Wealth and Poverty of Nations. He spends considerable time in applying perspectives gained from one field of study into other disciplines -- especially capital allocation.

At the Wesco(AMEX: WSC) annual meeting this year, Munger acknowledged that the first few hundred million dollars at Berkshire came from "running a Geiger counter over everything," but the subsequent tens of billions have come from simply "waiting for the no-brainers" or, as Buffett puts it, "waiting for the phone to ring."

Buffett still has a tendency to run his Geiger counter over lots of stuff. It's just too enticing intellectually not to. How does he avoid getting into trouble? I believe there are three reasons:

1. Running the Geiger counter can work very well if one knows when to run it. Reflect on the following two quotes:

In 1970, showing his dismay at elevated stock prices, Buffett said: "I feel like a sex-starved man on a deserted island."

In 1974, expressing his glee at the low levels to which the market had fallen, he said: "I feel like a sex-starved man in a harem filled with beautiful women!"

By 1970, he had terminated his partnership and made virtually no public market investments until 1974. The P/E ratio for the S&P 500 dropped from 20 to 7 in those four years. By 1974, he had acknowledged selling "stocks he'd bought recently at 3 times earnings to buy stocks selling at 2 times earnings."

Then, from 1984-1987, Buffett did not buy a single new equity position for the Berkshire portfolio. Berkshire Hathaway was sitting on a mountain of cash, and still he did nothing. In the latter half of 1987, Berkshire used that cash pile to buy over a billion dollars' worth of Coca-Cola(NYSE: KO), over 5% of the company. He invested 25% of Berkshire Hathaway's book value in a single company that they did not control!

What were Buffett and Munger doing from 1970-1973 and 1984-1987? Both men realize that successful investing requires the patience and discipline to make big bets during the relatively infrequent intervals when the markets are undervalued, and to do "something else" during the long periods when markets are fully priced or overpriced. I'm willing to bet that Buffett was playing far more bridge in 1972 than he was in 1974.

2. The Geiger counter approach works better in smaller, under-followed companies and a host of special situations. Given their typical smaller size, investing in these companies would do nothing for Berkshire Hathaway today. So Buffett usually makes these investments for his personal portfolio. A good example is his recent investment in mortgage REIT Laser Mortgage Management (LMM), where there was a decent spread between the liquidation value and quoted stock price. These LMM-type investments are significant for Buffett's personal portfolio and, more importantly, soak up intellectual horsepower that might lead to not-so-good results at Berkshire Hathaway.

Being versatile, he moves his Geiger counter away from the equity markets to other bastions of inefficiency whenever the public markets get overheated. These include high-yield bonds (Berkshire bought over $1 billion worth of Finova bonds at deep discounts in 2001), REITs (bought First Industrial Realty in 2000 for his own portfolio at a time when REIT yields were spectacular), or his recent investing adventures in silver.

3. The Munger/Buffett relationship is an unusual one. Both men are fiercely independent thinkers, and both prefer working alone. When Buffett has an investment idea, after it makes it through his filter, he usually runs it past Munger. Munger then applies his broad latticework of mental models to find faults with Buffett's ideas, and shoots most of them down. It is the rare idea that makes it past Buffett, and it has to be a total no-brainer to make it past both of them.

The Buffett/Munger approach of multi-year periods of inactivity contrasts starkly with the frenzied activity that takes place daily at the major exchanges. Which brings me back to the fundamental question: Why have we set up portfolio managers as full-time professionals with the expectation that they "do something smart" every day? The fund management industry needs to reflect on Pascal's potent words and how Warren Buffett and Charlie Munger have figured out how to sit quietly alone in a room, indefinitely.

Guest writer Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. He owns shares of Berkshire Hathaway. You can email him at mpabrai@pabraifunds.com, or find him on the Rule Maker discussion boards. To read his other writings, visitwww.pabraifunds.com. The Motley Fool is investors writing for investors.
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Mohnish Pabrai’s portfolio is not perfect because of what is inside, but rather because of how the fund is assembled. Pabrai is the managing partner of the Pabrai Investment Funds, a partnership with $500 million under management. Besides the 29% returned annually to partners, Pabrai has designed brilliant portfolio concepts.

Incalculable amounts of time are spent studying which investments to buy, but very little time is spent thinking about how much. The decision is usually left up to the investor’s confidence in the investment, something that has been shown to be unstable. The truth is, deciding how much to buy can have a large impact on a portfolio, occasionally just as much as what is bought. There are copious amounts of information on what to buy, but very little on how much.

To combat his untrustworthy feelings of self-confidence, Pabrai developed a new “portfolio theory.” I will call it the ten by ten portfolio. Ten investments that each make up ten percent of the portfolio. Pabrai holds between seven and fifteen different investments, but appears to stay close to the ten by ten benchmark. The fund is difficult to proportion perfectly, because a stock can run up before a full lot has been purchased or because a previous position has already advanced.

The proportioned ten by ten portfolio has other, less obvious effects. The benchmark percentage ensures the investor is confident enough to place 10% of their holdings in the investment. If they aren’t, then they should not invest at all. Simply put, the portfolio attempts to ensure only the best ideas get in.

As Buffett says repeatedly:
“ When making investments, pretend in life you have a punch-card with only 20 boxes, and every time you make an investment you punch a slot. It will discipline you to only make investments you have extreme confidence in.”

Additionally, a portfolio with ten stocks is focused enough to be able to beat the market, but not so focused that one wrong pick means the death of the whole fund. Pabrai admits he knows he is not as good a judge as Warren Buffett, who put nearly his entire wealth into GEICO stock at a young age. Therefore, if Pabrai is wrong, his fund can still do quite well. He has been wrong in the past ten years, while still returning nearly thirty percent per year after expenses.

Pabrai gave the following portfolio as an example at his 2005 annual meeting. He provided the following information to demonstrate how the ten by ten portfolio will do well even with some bad investment decisions.




Invested


Returned

Holding 1


$100


$10

Holding 2


$100


$50

Holding 3


$100


$100

Holding 4


$100


$100

Holding 5


$100


$180

Holding 6


$100


$180

Holding 7


$100


$180

Holding 8


$100


$200

Holding 9


$100


$200

Holding 10


$100


$300




$1,000


$1,500



He went on to explain that if the above returns took three years to achieve; the fund would have an annual return of 14.5%. If the returns took two years to achieve, the fund would have returned 22.5% per year and if only one year passed, the return would be 50%.

Another Pabrai concept is the “placeholder.” He contends that money sitting in the bank is actually risky because of the potentially declining dollar. Economically speaking, this is true. To combat the risk, Pabrai believes one should invest the cash in something safe, yielding enough return value. Currently, he is using Berkshire Hathaway as a placeholder until he finds other cheaper investments. Putting the money in the hands of the world’s greatest investor seems like a better idea than leaving dollars in the bank.

A past placeholder returned an annualized rate of about 116%. In mid October of 2004, Pabrai began buying Canadian Oil Sands, a company that owns 35% of Syncrude, when oil was forty dollars a barrel. The stock price was still undervalued by over 25% in comparison to the price of oil at the time, and appeared to value the company as if oil was never going to rise. In essence, Pabrai decided to take his cash and buy crude oil reserves at thirty dollars instead. He believed this to be a “productive commodity hedge against a declining dollar.”

He began buying the stock at forty-eight dollars and eighty one cents. Over an average of fourteen months, Pabrai had realized a gain of 145%.

His rational was stunningly simple. If oil prices did not rise, Pabrai did well from the dividend he was collecting. If prices rose to forty or fifty dollars a barrel, then he won big. Oil as it turned out climbed around sixty dollars and Pabrai began selling. He had invested in a stock that appeared to have little risk, was already selling at a decent discount, and had a catalyst to rise a great deal in the future.

Pabrai knows the dollar over time will likely decrease in value, and he has developed a concept to protect his portfolio from the risk. He has chosen to buy commodities or other safe companies that will be a better steward of his cash.

The last part to Pabrai’s portfolio is actually the first concept he addresses when researching an investment and is unique to the Pabrai Investment Funds.

In an article published on February ninth, 2004, Pabrai explains what he calls the “Yellowstone Factor”. He explained that Yellowstone national park is actually one large volcano that statistically speaking erupts every six hundred thousand years, with enough force to kill everyone within 700 miles. An eruption has not occurred in six hundred and thirty thousand years.

Therefore Pabrai explains, no matter how small the probability an event might occur, the risk must be taken into consideration. He goes on to point out that no business on earth is totally risk free. There is always a Yellowstone.

Before Pabrai makes any investment, he will “first fixate on what factors can cause the investment to result in a significant permanent loss of capital”. He believes simple estimations or “back of the envelope accounting” is all that is required. Similar probabilities can be assigned to other kinds of risk such as accounting fraud.

While the analogy of Yellowstone erupting is interesting, the message is paramount. Consider all possible risks of loss and ascribe a probability of the event occurring.

To reduce risk as much as possible, Pabrai ensures his holdings have little overlap. For instance, he will usually only hold one investment in the oil industry. He can minimize industry specific risk effectively by isolating his holdings.

Pabrai has simplified portfolio design with straightforward concepts. He has whittled Buffett’s ideas into easily followed rules. By limiting holdings, hedging against the declining dollar, and estimating risk, Pabrai has developed a portfolio that will certainly improve any investor’s performance.
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Mohnish Pabrai, is Managing Partner of Pabrai Investment Funds, a group of focused value funds. Since inception in 1999 with $1 million, Pabrai Funds has grown to over $500 million in assets under management. Pabrai is the author of two books on value investing,Mosaic andThe Dhandho Investor.

Mohnish Pabrai’s talk centers on checklists for investing. Mohnish “highly, highly recommends reading Dr. Atul’s book,The Checklist Manifesto: How to Get Things Right.”

In 1935 when the US was looking for next bomber, Boeing invented the B-17 bomber widely exceeded everything the army had previously put out, however they had a test run and two pilots died.

Boeing went back to look at what happened. And they realized that this was too complex. So Boeing engineers came up with a checklist. Afterwards the plan had a flawless bomber.

Today the aviation check list has become very organized, and the pilots are trained to live and die by that checklist.

The list is highly practical and easy to understand. The checklist is extensively researched and is stimulated by flight simulators to see if anything should be added or subtracted.

In America there are five million lines inserted into America in ICUs. About 80% of these line insertions led to infection, of which 20-25% of which were fatal.

A doctor in John Hopkins had nurses stand by the doctors before line insertions.

He listed five points in his check list which are all pretty basic thinks like washing hands with soaps before line insertions.

Nurses noticed that a lot of these rules were missed, so he had the nurses make sure the doctor kept to the five rules. After this happened the amount of infections went down to zero. He took this approach to other hospitals. And nowadays this procedure has become standard in US hospitals.

The FAA is actually one of the most successful agencies.

The FAA has very little to do with actual flights, they only go into action when an accident occurs. The FAA gets down of what happened. Bird hits happen to be a major problem for airplanes. When the Hudson crash occurred due to the Canadian geese, the FAA made sure to keep better track of Canadian Geese.

Flying is very cheap and safe. However, the nuclear industry took a different approach which was not pragmatic and could not tolerate a single human life. And we are praying the price 20 years later.

Mohnish found that the FAA approach could be used in investing. He compares a crash to a loss of capital.

Mohnish started building an investment checklist. He looked at mistakes Warren Buffett and Charlie Munger made and mistakes by other great value investors.

Mohnish compiled a list of 70 items two years ago. Since then Mohnish has achieved a zero error rate. However, Mohnish warns there are bound to be errors in the future.

Mohnish looked at many the great fund’s 13Fs from 2004 to see approximately what their buy price and look at their sell price. He analyzed twelve investors and came up with a list of 320 companies that these investors lost money in totaling $20 billion. He looked at why they might have bought and sold these securities.

He picked 26 of the 320 companies and looked in depth at them. He only looked at three financial companies to diversify across industries. Now Mohnish is up to 97 points in his checklist.

Mohnish quotes Jack Welsh as stating that GE will only be in an industry where they are number one or two.

HP and Lexmark had a duopoly in printers. Oakmark and Davis Funds lost a lot of money in Lexmark.

However, if you looked at checklist you likely would have avoided this investment. Lexmark was more similar to Schick than to Gillette.

One are with the largest area of mistakes has to do with moats. The question that must be asked is if the moat is sinking. LongLeaf lost $550 million in Sun Micro systems.

There was a huge decrease in computer prices over the past few years, plus a shift from desktops to laptops this affected Dell a lot. LongLeaf, and Fairfax had some pain in that company.

LongLeaf bought GM thinking that GM owned the truck business. When gas went to $4, GM was decimated. One of the checklist items is to look at what other factors can affect a moat in this case being commodity prices.

There are give categories in the check list:

Personal biases are a small part.

Leverage, Management, Moat and valuation are the main four items of the checklists.

The checklist highlights the possible main failure points. But there will never be an investment that will fit all 97 items.

Mohnish is currently building a cheap Japanese basket of cheap stocks. Mohnish believes there is a great opportunity in that market. Despite the fact that it is hard to invest in the low cap and micro cap Japanese stocks.

Mohnish does not currently have a checklist for selling.
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Forbes.com


Intelligent Investing Transcript
Transcript: Mohnish Pabrai
Steve Forbes, 04.12.10, 6:00 AM ET

Lessons From Buffett

Steve Forbes: Mohnish, thank you very much for joining us today.

Mohnish Pabrai: You're most welcome.

Forbes: You are one of the noted value investors, one of those who is an admirer of Warren Buffett. What did you take from Warren Buffett? And what do you do differently from Warren Buffett? You're not a clone.

Pabrai: 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. 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, I think, most of the great things I've taken from Warren have more to do with life than investing.

Forbes: Such as?

Pabrai: Well, such as, you know, how to 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.

Forbes: They do interconnect. Now, in terms of how you approach an investment, you, I think, probably pay more attention to intangibles than perhaps Warren Buffett or Ben Graham might have done.

Pabrai: Well, Warren pays attention to intangibles, but Ben Graham was very much a tangible guy. And yeah, so we're looking at the qualitative as well as the quantitative. And yeah, so I would say that one way to look at that is to consider what Charlie Munger would call his latticework of mental models. So 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.

Forbes: Munger also said, "You have three choices: yes, no, or too difficult." You subscribe to that too.

Pabrai: That's right. And 98% is too difficult.

Find Deep Moats

Forbes: So that gets to knowing your areas of competency. 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.

Pabrai: Yeah, you know, 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 saw firsthand that the durability of technology moats is many times an oxymoron.

Forbes: Now quickly define moats, in terms of a business that keeps the competition away.

Pabrai: Well, you know, if you talk to Michael Porter, he would give you five books on what is meant by, 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 word. But basically it's the ability of a business to have 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 moats. Some have broad moats. Some have moats 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. That's a great business.

Invest Leisurely

Forbes: So summing up in terms of what do you think do you bring to value investing that others perhaps don't, that give you a unique edge?

Pabrai: 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.

Forbes: So what's that saying of Pascal that you like about just sitting in a room?

Pabrai: Yeah. "All man's miseries 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."

Forbes: So you don't feel the need to pick 10 stocks a quarter or one stock a quarter, just what turns up?

Pabrai: 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 task aside and go to work. That would be the ideal way to set up the investment business.

Forbes: Does this tie into your ideas and other value investors' ideas of low risk, high uncertainty?

Pabrai: That's right. I mean, I think the low risk, high uncertainty is really something I borrowed from entrepreneurs, and you know, the Patels in India or the Richard Bransons of the world. Basically 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. They want free lunches and they go after free lunches. And so if you study any number of entrepreneurs, from Ray Kroc to, you know, Herb Schultz at Starbucks and to even Buffett and Munger and so on, what you'll find is that they have 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.

Low Risk, Low Capital

Forbes: 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 started another company. It did not work. What did you learn from that that gave you insights on investing that, those that had not been in the trenches, don't bring?

Pabrai: Well 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.

Forbes: You thought you knew what you were doing.

Pabrai: 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 now the third business, if you call Pabrai Funds a business--I call it a "gentleman of leisure" activity--but Pabrai Funds is, again, low risk, high uncertainty in the sense that there is no downside. It never took capital. So it's a great business.

Forbes: So as a gentleman of leisure, is that why you take a nap each day at 4 p.m.?

Pabrai: There's nothing better. Do you have a nap room?

Forbes: I wish.

Pabrai: You know, when I went to Warren's Berkshire headquarters last year, my friend Guy asked Warren, he said, "Warren, Mohnish has a nap room in his office. Do you have a nap room?" And Warren's answer was, "Yes." OK, so I was surprised. So I said, "Warren, you're telling me in Kiewit 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."

Forbes: Well there's something to that. My father called it having a conference.

Pabrai: That's right. No, it does wonders. I have a hard time getting past the day without the nap, so the nap is a must.

Forbes: So having those two experiences--no capital, then as you say, fat and happy and then you got your head handed to you--when you look at an equity, when you look at a possibility, what are those experiences, give what insight do you get from those experiences.

Pabrai: Well, the insight is the same, in the sense that I think that, you know, Warren says that I'm a better investor because I'm a businessman, and I'm a better businessman because I'm an investor. So the thing is that my experiences as a businessman have very direct, 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 important thing that value investors focus on is downside protection. And that's exactly what entrepreneurs focus on--what is my downside? So that is the, I would say, the crossover between entrepreneurship in investing, and value investing especially, is protecting your downside.

Pabrai's Fees

Forbes: Now you're a hedge fund manager, but you're unusual. First, your fee structure. Explain that.

Pabrai: Well you know, my fee structure, one of my attributes about a great investor is be a copycat. Do not be an innovator.

Forbes: What's it, pioneers take the arrows?

Pabrai: Yeah. When I started Pabrai Funds, I actually didn't know anything about the investing business. And the only, 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 profits, after a 6% hurdle. And all of that made all the sense in the world to me, because I felt it aligned my interests 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 Pabrai Funds. Because the investors who joined 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.

Forbes: You're also unusual in another way. You don't seem to go out of your way to woo institutional investors.

Pabrai: Yeah, I mean, I think 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 going to look at allocations every quarter or might need to redeem in a year and those sorts of things. So their frameworks are very different. So in general--

Forbes: So someone who comes with you is a minimum of, what, two years, three years, what, before you allow them an exit?

Pabrai: Our exits are annual. So people can get out once a year. 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, because people can have hardships. They can have all kinds of things happen.

Forbes: Now, low cost, one of the things that apparently institutional investors are flummoxed by is, it's you.

Pabrai: Our total 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 everything. They don't pay for my salary or my staff's salary. We take that out of the performance fees. And they only pay the performance fees after 6%. So what a deal.

Forbes: Now, you're not big on schmoozing investors.

Pabrai: You know, I think the thing is that every business ought to figure out who their ideal customer is.

And at Pabrai Funds, what I've found is that investors who do their own homework find me and do the research on me on their own, without any middlemen involved, and then invest in Pabrai 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 analysts at the best price with no conflict of interest. So it works out great.

Forbes: Free. That sounds really good. They pay you.

Pabrai: Yeah, exactly. It's great.

Forbes: You're not even registered with the SEC?

Pabrai: 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 have audits by Pricewaterhouse. We have to report 13fs to the SEC. So I think there's plenty of disclosure and transparency.

Forbes: You also don't engage in things like short-selling.

Pabrai: 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?

Forbes: You focus on a handful of individual investors, maybe institutional investors, but people who know you, are with you.

Pabrai: Right.

Forbes: You're not part of a formula, not spit out of a computer.

Pabrai: That's right.

Use Index Funds

Forbes: What's an individual investor to do? You have some unique advice for individual investors.

Pabrai: Well 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 Munger's response was very simple. 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 paycheck, he said, "that in, what, 20, 30, or 40 years, you can't help but be rich. It's just bound to happen."

And so any 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, to split it amongst them--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 indexes. But even the 10% or 20% who do, only one in 200 managers outperforms the index consistently by more than 3% a year. So the chances that an individual investor will find someone who beat the index by more than 3% a year is less than 1%. It's half a percent. So it's not worth playing that game.

Forbes: And in terms of index funds, S&P 500 or--

Pabrai: 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, 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.

Don't Go in the Roach Motel

Forbes: On TV when these folks make recommendations--you compare it to if you buy something that you heard somebody recommend on TV as going into the roach motel. Can you please explain?

Pabrai: Well you know, you remember those ads that ran where the roaches check in.

Forbes: Yup.

Pabrai: But they never check out. So the thing is, you watch some talking head on TV. And he tells you, "Go buy whatever company, 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--

Forbes: Or if it goes up, do I get out? Do I wait?

Pabrai: 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 the 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.

The Chinese Books

Forbes: And looking around the world, you made mention I think in the past, if you want an index fund with the emerging markets, OK. But you have us take a skeptical eye to investing in other countries around the world. You don't preclude it, but you see some risks.

Pabrai: Well, you know, Steve, there's plenty of great opportunities in many countries. But I would say it's probably a no-brainer to avoid Russia, Zimbabwe. And even if you look at a place like China, which I think will create incredible amount of wealth for humanity in this century, 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 I think in Chinese companies, or even in Indian companies, 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.

Forbes: You also say you don't think you get much talking to CEOs, because they're in the business of sales.

Pabrai: Yeah, you know, 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. But they got to those positions because they have charisma and they are great salespeople. 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 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.

Forbes: And what areas are you looking at right now? You remember back in 1968, '69, we did a story on Buffett when he was fairly unknown. And he was getting out of the market, height of 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%. And he politically incorrectly said that he felt like a sex maniac in a harem because of all the bargains around.

Pabrai: Right.

Forbes: You've probably had the same feeling a year ago. What do you see? How does the harem look now?

Pabrai: That's right. In 1969 Warren told you "I feel like a sex-starved man on a deserted island." And in '74, that deserted island had become a harem. Well nowadays, we're twiddling our thumbs. It's good that I enjoy playing racquetball and bridge and so on. So there's a lot of bridge. There's a lot of racquetball. And you know, I have an eye out on the markets, but there's just not a whole lot of value presently. But value can show up tomorrow, for example. So we're not in a hurry. Happy to have a leisurely lifestyle and wait for the game to come to us.

Make Checklists

Forbes: So in the first quarter of 2010, did you add any positions?

Pabrai: Yeah, actually, we did. We did find. In fact, there's one I'm buying right now. But I found two businesses, but they're anomalies. They were just, you know, businesses that had distress in them because of specific factors. And I think we'll do very well on both of them. They'll go nameless here. But no, 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 that is definitely not the case today.

Forbes: And finally, telling you about mistakes, one of the things I guess an investor has to realize, they cannot control the universe. Delta Financial: You had done the homework, you fell and then events took it away from you.

Pabrai: Well Delta Financial was a full loss for the firm, for the fund. We lost 100% of our investment. It was a company that went bankrupt. And we've learned a lot of lessons from Delta. And one of the lessons was that 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 they were caught flat-footed. And so there's a number of lessons I've obviously learned from Delta.

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 own portfolio, those lessons stay with you for a long time.

Forbes: So that gets to, you're a great fan of The Checklist Manifesto. And you now have checklists. 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."

Pabrai: Yeah, so the checklist I have currently has about 80 items on it. And even though 80 sounds 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 starting 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 to the checklist. And I run it against the 80 items. And what happens the first time when I run it, there might be seven or eight questions that I don't know the answer to, which is great, which what that means is, "Listen dummy, go find out the answer to these eight questions first." 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 good news is that you're looking in front of you 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, kind of, you have a go, no-go point, where you can say, "I'm comfortable with these risk factors here. I'm comfortable with probabilities. And I'll go ahead with it." 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 10x10 portfolio, which is when I'd make a bet, it was typically 10% of assets. And after I incorporated the checklist and I started to see all the red flags, I changed my allocation. So the typical allocation now at Pabrai Funds is 5%. And we'll go as low as 2%, if we are 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 so the portfolio has become more names than it used to have. But since we started running the checklists, 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 Pabrai Funds. We made a huge number of investments, more than any other period, any other 18-month period in our history. So with more activity so far, and 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 key. The thing is that Warren says, "Rule No. 1: Don't lose money. Rule No. 2: Don't forget rule No. 1." OK, so 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.

Forbes: Can you give a couple of the things that are on your 80 [item] checklist?

Pabrai: Oh yeah, sure. The checklist was created, looking at my mistakes and other investors' mistakes. So for example, there's questions like, you know, "Can this business 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, you know, high-interest credit cards and they make a lot of money, that's not exactly, you know, helping society. So you might pass on that. Also, a liquor company or tobacco company, those can be great businesses, but in my book, I would just pass on those. Or a gambling business, and so on.

So the checklist will kind of focus you more toward playing center court rather than going to the edge of the court. And there's a whole set of questions on leverage. 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 interests of management. You know, just a whole--on their historical track records and so on. So there's questions on unions, on collective bargaining.

So you know, and all of these questions are 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 CORT Furniture, which was a Charlie Munger investment. And that was an 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 question came from there. So the checklist questions, I think, are very robust, because they're based on real-world arrows people have taken in the back.

Forbes: Terrific. Mohnish, thank you.

Pabrai: Well thank you, Steve.
-----------------------------
Los Angeles hedge fund manager Mohnish Pabrai, 39, seems to have some talent as a stock picker. Since he started Pabrai Investment Funds in 1999, he has delivered a 35.3% compound annual return (after fees), to the 14.2% a year you would have made owning Berkshire shares.
There are two reasons the $116 million portfolio has done better than the competition in Omaha. One, says Pabrai, is that he doesn't try to emulate Berkshire's holdings in wholly owned subsidiaries. That has kept him out of property/casualty insurance, which accounts for a big part of Berkshire's revenue and had suffered some setbacks (such as claims from Sept. 11). The other is that he hews a little more closely to the kind of value investing espoused by Buffett's mentor, Benjamin Graham. Graham liked to buy companies for less than net current assets, meaning cash, inventory and receivables minus all obligations. Buffett has pushed the definition of intrinsic value in new directions. He is willing to pay for intangibles, like a consumer brand name or a newspaper monopoly, provided those assets throw off "owner's profits"--cash that can be extracted from a business after necessary capital outlays are paid for.

Like Buffett, Pabrai keeps his distance from Wall Street. He buys no research and has no hired help. If he can't understand a company, he doesn't buy the stock. Further, Pabrai won't meet with a company's executives; if he socializes with one, he'll never invest in the stock. "Chief executives are salesmen, as Graham says," Pabrai intones. "That's how they get their jobs."

Pabrai last year bought the Norwegian oil tanker firm Frontline when shipping rates fell to $5,000 a day. To remain profitable, the company needs rates of at least $18,000 a day on its 70 double-hulled oil tankers. Investors fled the stock, and it fell to $3. Frontline wasn't a classic Graham value play since it didn't have much in the way of net current assets. But it did have hard assets--those tankers.

After noticing the stock on a new lows list, Pabrai looked into the oil shipping business and discovered that small Greek shippers with near-obsolete single-hulled tankers were being hurt more than Frontline and were selling their ships for scrap. So he knew that when oil demand next surged, Frontline would be better able to command premium rates. Near the end of 2003 Frontline was charging $50,000 a day per tanker. Pabrai is long gone, but the stock, at $29 a share, trades at a cheap five times trailing earnings.

In 2002 he beat Buffett to the convertible bonds of Level 3 Communications. Like his hero, Pabrai saw value in telecom's distress.

C. Douglas Davenport, manager of the $52 million Wisdom Fund in Atlanta, is Buffett's shadow. If Buffett does something, Davenport will, too--going so far as to buy proxy stocks for companies that Berkshire acquires. Davenport keeps the identical proportion of cash that Berkshire does, a sizable 22% of his portfolio.

Davenport's fund, with backing from Sir John Templeton's family, started in early 1999 as the Berkshire Fund but changed its name after the real Berkshire complained. Davenport, 53, follows Berkshire's public filings and news reports to see what Buffett has been up to. "Buffett is quite well followed. It's amazing how much you can find out about the man on the Internet," he says. Thus Davenport has 8% of his assets in Coca-Cola, and 4% in American Express, just like Berkshire.

When Berkshire acquired carpetmaker Shaw Industries in 2001, Davenport went after competitor Mohawk Industries, waiting two weeks for its share price to settle down. Last year Berkshire bought Clayton Homes, a builder of prefab homes, and Davenport bought into similar Champion Enterprises. To roughly match Berkshire's huge stakes in auto insurance and reinsurance, Davenport has American International Group.

Since inception just over five years ago Wisdom is up an annual 5.2%, after its 1.5% expense ratio, matching Berkshire's showing.

November 21, 2010

Mohnish Pabrai

We will never see another Warren Buffett

http://files.arunbansal.com/pdf/Interview_With_Mohnish_Pabrai.pdf
http://www.aboveaverageodds.com/resources/
http://twitter.com/AboveAvgOdds
http://www.gurufocus.com/news.php?author=Valuehuntr


DNA / Vivek Kaul / Wednesday, October 21, 2009 2:02 IST

Mohnish Pabrai currently manages Pabrai Investment Funds, which he founded in 1999. The fund has around half a billion dollars in assets under management. Pabrai went to the US in 1982 to do his undergrad in computer engineering. After that, he worked with Tellabs in Chicago. In 1990, he started his own company TransTech, an IT services/system integration business and ran that for around ten years, before starting Pabrai Investment Funds. He has written a book on investing, The Dhandho Investor: The Low-Risk Value Method to High Returns. Excerpts from an interview:

How did you get into investing business from information technology?
Around 1994 I heard about Warren Buffett for the first time accidentally. The first couple of biographies about him had just been published a year or two before that. I read those books and I was quite blown away by some data points that were coming out about him and the industry and so on. I didn't have any experience or even education in the investment business. But I was very intrigued by it.

I started to invest in the public equity markets using Buffett's model in 1994 and basically did extremely well, north of 70% a year, till about 1999. I was getting more and more interested in investment research and securities analysis and made a decision to leave my company. I brought in an outside CEO and decided that I would spend more time on investing and at the same time some friends of mine wanted me to manage their money for them. It started as a hobby in 1999 with about a million dollars from eight people. About a year later the business (TransTech) actually got sold, I wasn't running it anyway, but I was completely cashed out. And then I thought that let's make my hobby a real business, try to scale it up and get investors. We now manage about $500 million — ten years later.

How did you narrow down on Warren Bufett and value investing?
Basically in 1994, when I read about Buffett, there were two things that stood out. One was that he had compounded money at a very high rate. If you are compounding at a high rate, even if you have a small amount of money — let's say a million dollars — in thirty years you could have a billion dollars. So the idea of compounding at a rate above the market rate is an extremely fine notion because it can lead to enormous wealth creation. That was the first thing.

The second thing was that the way Buffett was compounding money at a rate higher than the market was based on a core wisdom which he stood for. If you are physicist, whether you believe in gravity or not, it will always impact you. Just like there are laws of physics, laws of gravity, there are laws of investing.

I noticed in 1994 that the mutual fund business had two things: one, they did not follow the laws of investing, and two, their results were affected by the fact that they did not follow the laws of investing.

For example, a basic law of investing is that you make very few bets, you don't buy a hundred companies because you are not going to have an understanding of business. But if you look at mutual funds, that is not the way they operate.

So essentially, what you are saying is that investors should make fewer bets?
So you make few bets, you make big bets, infrequent bets and you only make bets when the odds are heavily in your favour. What I found very funny was that here is a guy (Buffett) who is telling you very much the approach to investing he follows, and this is like Newton telling you the laws of physics. The second thing is that the investment industry does not care about these laws, and their results reflect it.

The third conclusion I came to is, I said, OK, if what I am saying is right, what it means is that a person like myself, who has no experience in this industry, could come in and apply Buffett's rules and do better than all these managers running all these funds. So I said, well, that hypothesis means nothing until you test it out. I had an asset sale take place of a part of my business in 1994, and I had about million dollars in cash, sitting with me for which I did not have any need for.

I decided I am going to take this million and put this on a twenty or thirty-year compounding engine. I was about 30 years old, I wanted to see if by the age of sixty I had my billion dollars. I started playing this thirty-year game in 1994, and basically I found that first of all, it was very enjoyable and second, that it's been fifteen years now and the original hypothesis I had is absolutely correct — which is that the industry doesn't get it, they still haven't changed their ways, and there results reflect that.

What are the factors you look at before deciding to invest in a company? Can you give us an example?
The first thing you got to look at is, "I am not buying a stock, but I am buying a business." And you only buy the business if you were willing to buy the entire business if you had money for it. So, for example, if Reliance Industries has a market cap of $100 billion and you had a $300 billion, the question you would ask yourself is, would I buy the entire business for a $100 billion?

The first thing is that you are not buying pieces of paper, but you are buying an entire business. The second is that you ask yourself, do I understand the business? Do I truly understand how it will work, how it makes money, how will it do in the future?
Then the third thing is, if Reliance produces$3 billion a year cash flow and it trades for $100 billion, I have no intention of buying it at 33 times cash flow. It is like I have no interest in putting money in an account that pays 3% interest.

So I love Reliance, maybe, if the fair value of business is 15 times cash flow, which is $45 billion. And since I am cheapskate, I don't want to buy it for more than half its fair value, so I just say to myself, that if it goes below $20 billion in value — or one-fifth the current price — then I will look at it again. In fact, that is the way to look at the Indian Sensex. You take all the Reliances, the Wipros and Infosyses of the world, chop their price by four, and that's your entry price.

What has been your most successful stockpick till date?
You know that's a very funny question. The most successful company I ever invested in is Satyam. I invested in 1995, and I was completely out by 2000. When I invested the stock was at Rs 40, and Satyam's earnings at that time were about at Rs 12 a share, so you were buying a business for three-and-a-half times earnings. And the more interesting thing for me was that property the company had in Hyderabad exceeded the market capitalisation as it was carried at a value that was bought a long time ago.

The only reason I knew about Satyam was because I was in the IT services space. These guys had actually visited us to see if they could do business together. And I had been pretty impressed by the way the business operated and the people I had met.

I looked at it from my investment point of view after was amazed that such a business could trade at such a price. So I invested in Satyam. In 2000, it was trading at Rs 7,000, that is about a 150 times the price I bought it at. This was in the days before demat, and actually when I bought the stock with an account through Kotak that I had in Mumbai, I was given physical delivery of these shares that looked like tattered pieces of paper that were falling apart.

Satyam from less than a PE of 3 to more than PE of 100. I just said I am out of it because now I owned a bubble stock even though I did not buy it at bubble price. I sold my entire position within 5% of the peak. Within six months it had dropped from Rs 7,000 to Rs 1,000, and continued on the sidelines for a while. That was the best deal that I ever made.

I also happened to read somewhere that you wear shorts to work and do not as a matter of habit short stocks?
Well, I am wearing shorts right now … the math for for shorting is really bad. When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?

Also, any time you short a stock, you are hooked to a (stock price) quote machine for life support because you have to watch what is happening all the time. Many a times, when I am travelling in India, it could be several days when I don't have a quote for any positions that I hold. So I don't want to be a in a situation where I have an umbilical cord linked to some quote machine … and blood pressure going up and down.

Do you have investments in emerging markets like India and China or do you stick to the stocks in the US market?
I would say that most times a very large portion of our portfolio has a lot of exposure to the global market. I have (shares in) several companies in Canada. I own (shares in) one Chinese company and an Egyptian company, I don't own any Indian companies right now, but I use to own Satyam. Also Pabrai Funds use to own Dr Reddy's.

You have said in the past that investment ideas come to you by reading a lot…
An investor should think of himself as a gentleman of leisure. Don't think that you are in some profession. You just think that you are a person who is focused on enjoying and living life well. If you focus on yourself as a gentleman of leisure what is going to happen is that you do not feel any compelling reason to act. It has been several months since I have bought any new stock. And that is not a problem because we went through a period in December when we bought ten stocks. The first thing is that we are in a profession were you don't pay for activity, you get paid for being right. So there should be no compelling reason to act. Basically, the thing you do is you take out the reason to act.
The second thing you do is you focus on acquiring worldly wisdom. I read an enormous amount of stuff and relate to what different investment managers who I respect are saying. So, at times, things become no-brainers.

In the fourth quarter of last year, when everything was going to hell, one part of the market that went to extreme hell was commodity-related stocks. Commodity-related stocks absolutely got crushed. 95% down. 90% down. And if you simply keep in mind that you look at the growth rates of India and China, you can get an insight.

Through our foundation Dakshina I spend a good amount of time in rural India. I can see nuances about India, that most people would not see. You can see that the pressure on the few commodities in the earth's crust is tremendous.

China has severe problems with fresh water and you really have big problems with agriculture with those type of water issues. When you have growth rates of 7-8%, people will want to eat the best. Generally it is proven that protein consumption climbs very high when economies do well. It is absolutely a given that 10 years from now the amount of agriculture and protein needed will be much higher from today. And getting there will not be easy.

So the thing is there are certain businesses that serve as toll bridges in that space. For example, one toll bridge is if you look at Latin America. It has a lot of land and it is flooded with fresh water rivers. South America can basically take that land and convert it into producing corn and soybean or whatever and export the hell out of it to China. And that is exactly what will end up happening. Latin American agricultural companies with large land holdings today are not excessively priced, they are very cheap. But there is absolutely no way for India and China to satisfy the consumption demand that is coming without going to Latin America. So we will just own the toll bridges and wait.

How much of Warren Buffett's success can be attributed to his investment prowess and how much to the fact that he is Warren Bufett?
Well the thing is you could have invested even after Buffett had invested and you could have made six times the money out of it.

In fact there are a couple of professors in Ohio, who studied any stock that Warren Buffett bought, if you bought on the last day of the month, when it was public that he owned that stock, and you sold it after it was public that he had started selling it, you would have generated north of 20% annual rate of return.

I would say that we will never see another Warren Buffett. Just like we will never see any Albert Einstein or another Mahatma Gandhi. Buffett is a very unique individual. His skillsets outside of investment are phenomenal but they get dwarfed by his investing skills. The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for, let's us say seventy years, and is continuously learning every day.

So the thing is if you want to be like Buffett, there is no short cut. First of all, you have to be deeply interested in investing and you have to be very willing spending tens of hours, hundreds of hours, reading the minutiae. There is a very famous value investor called Seth Klarman. He is into horse racing. And his famous horse is called Read the Footnotes.

URL of the article: http://www.dnaindia.com/money/interview_we-will-never-see-another-warren-buffett_1301088-all

Pabrai's Perspectives on Investing

Warren Buffett made billions buying shares of Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC), and Gillette (now a part of Procter & Gamble (NYSE: PG)) in the 1980s and 1990s. But before that, he was actually posting better returns investing in some companies you've never heard of, like Sanborn Maps, and some you have, like American Express (NYSE: AXP).

In those early days, Buffett's investing strategies were geared more toward special situations -- workouts, arbitrage, and liquidations. (Many people, based on comments Buffett has made, believe he makes more than 50% a year in his personal portfolio from special-situation investing.) From 1957 to 1968, Buffett's investment partnership posted 31.6% gross and 25.3% net annualized returns, respectively, in comparison with the Dow's 9.1% annual return.

Mohnish Pabrai, who was profiled in James Altucher's must-read Trade Like Warren Buffett, is an ardent Buffett follower, and his investment partnership likewise has a stellar track record. Pabrai's first book, Perspectives on Investing, was brilliant in its simplicity and ability to convey the principles of intelligent investing. Pabrai also has a new book, The Dhandho Investor, coming out soon. I thought Fools (myself included) would be very well-served to read up on some of Pabrai's thoughts, and the following is the first half of a two-part interview conducted with Pabrai via email.

Emil Lee: You've modeled your partnership after the Buffett Partnership -- do you mind providing any detail on how that's going? Are you on track in terms of performance, assets under management, etc.?

Mohnish Pabrai: It has gone far better than I would have forecasted. Mr. Buffett deserves all the credit. I am just a shameless cloner. A $100,000 investment in Pabrai Funds at inception (on July 1, 1999) was worth $659,700 on Dec. 31, 2006. That's seven and a half years. The annualized return is 28.6% -- after my outrageous fees and all expenses. Assets under management are over $400 million -- up from $1 million at inception. On all fronts, Pabrai Funds has done vastly better than my best-case expectations.

Going forward, I expect we'll continue to beat the major indices, but with just a small average annualized outperformance.

Lee: You clearly believe in having a broad latticework of knowledge from different educational disciplines from which to draw upon when judging investment ideas. Can you describe how you spend your day? Do you devote a general percentage of your time to reading "non-investment" material versus 10-Ks, etc.?

Pabrai: My calendar is mostly empty. I try to have no more than one meeting a week. Beyond that, the way the day is spent is quite open. If I'm in the midst of drilling down on a stock, I might spend a few days just focused on reading documents related to that one business. Other times, I'm usually in the midst of some book, and part of the day goes to keeping up with correspondence -- mostly email.

I take a nap nearly every afternoon. There is a separate room with a bed in our offices. And I usually stay up late. So some reading, etc., is at night.

Lee: In Trade Like Warren Buffett, you mention that you let investment ideas come to you by reading a lot, and also monitoring familiar names on the NYSE. Can you describe your process of generating investment ideas -- is it simply just reading a lot? Do you do anything else to actively seek out ideas?

Pabrai: The No. 1 skill that a successful investor needs is patience. You need to let the game come to you. My steady-state modus operandi is to assume that I'm just a gentleman of leisure, and that I'm not in the investment business. If something looks so compelling that it screams out at me, saying "Buy me!!," I then do a drill-down. Otherwise, I'm just reading for reading's sake. So, I scan a few sources and usually can find something scream out at me a few times a year. These sources (in no particular order) are:

1. 52-Week Lows on the NYSE (published daily in The Wall Street Journal and weekly in Barron's)
2. Value Line (look at their various "bottoms lists" weekly)
3. Outstanding Investor Digest (www.oid.com)
4. Value Investor Insight (www.valueinvestorinsight.com)
5. Portfolio Reports (from the folks who put out OID)
6. The Wall Street Journal
7. Financial Times
8. Barron's
9. Forbes
10. Fortune
11. BusinessWeek
12. The Sunday New York Times
13. The Value Investors' Club (www.valueinvestorsclub.com)
14. Magic Formula (www.magicformulainvesting.com)
15. Guru Focus (www.gurufocus.com)

Between all of the above, I have historically found at least three to four good ideas every year. Sometimes I make a mistake, and a good idea turns out to be not so good.

Lee: A big part of investing is knowing what to pay attention to and what not to [focus on]. How do you sift through the thousands of investment ideas? Often, bargains are bargains because they're unrecognizable -- how do you spot the needles in the haystack, and how do you avoid the value traps?

Pabrai: I wait to hear the scream. "Buy me!" It needs to be really loud, as I'm a bit hard of hearing.

Lee: Would it be fair to say you are more balance sheet-oriented, versus income/cash flow statement-oriented? If so, how do you get comfortable with the asset values (i.e., Frontline, death care)?

Pabrai: John Burr Williams was the first to define intrinsic value in his The Theory of Investment Value, published in 1938. Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows -- discounted at an appropriate interest rate -- that can be expected to occur during the remaining life of the business. The definition is painfully simple.

So, cash can be gotten out of a business in a liquidation or by cash the business generates year after year. It is all a question of what is the likelihood of each. If future cash flows are easy to figure out and are high-probability events, then liquidation value can be set aside. On the other hand, sometimes the only thing that is a high probability of value is liquidation value. Both work. Depends on the situation. But you first need to hear a scream ...

A worthy successor
Pabrai's answers have provided a great look into the thoughts and habits of an excellent value investor. In fact, he's one of a handful alive who are generally acknowledged as worthy of following in Buffett's footsteps (Pabrai was nominated as a "Buffetteer" by Forbes magazine). Like Buffett, Pabrai gives credence to the theory that activity shouldn't be confused with productivity, but instead tends to result in friction.

Be sure to tune in tomorrow, when we publish the second part of the interview and find out more about how to become a better investor.

For more interviews with other hedge fund managers, check out:




Pabrai's Perspectives on Investing

Warren Buffett made billions buying shares of Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC), and Gillette (now a part of Procter & Gamble (NYSE: PG)) in the 1980s and 1990s. But before that, he was actually posting better returns investing in some companies you've never heard of, like Sanborn Maps, and some you have, like American Express (NYSE: AXP).

In those early days, Buffett's investing strategies were geared more toward special situations -- workouts, arbitrage, and liquidations. (Many people, based on comments Buffett has made, believe he makes more than 50% a year in his personal portfolio from special-situation investing.) From 1957 to 1968, Buffett's investment partnership posted 31.6% gross and 25.3% net annualized returns, respectively, in comparison with the Dow's 9.1% annual return.

Mohnish Pabrai, who was profiled in James Altucher's must-read Trade Like Warren Buffett, is an ardent Buffett follower, and his investment partnership likewise has a stellar track record. Pabrai's first book, Perspectives on Investing, was brilliant in its simplicity and ability to convey the principles of intelligent investing. Pabrai also has a new book, The Dhandho Investor, coming out soon. I thought Fools (myself included) would be very well-served to read up on some of Pabrai's thoughts, and the following is the first half of a two-part interview conducted with Pabrai via email.

Emil Lee: You've modeled your partnership after the Buffett Partnership -- do you mind providing any detail on how that's going? Are you on track in terms of performance, assets under management, etc.?

Mohnish Pabrai: It has gone far better than I would have forecasted. Mr. Buffett deserves all the credit. I am just a shameless cloner. A $100,000 investment in Pabrai Funds at inception (on July 1, 1999) was worth $659,700 on Dec. 31, 2006. That's seven and a half years. The annualized return is 28.6% -- after my outrageous fees and all expenses. Assets under management are over $400 million -- up from $1 million at inception. On all fronts, Pabrai Funds has done vastly better than my best-case expectations.

Going forward, I expect we'll continue to beat the major indices, but with just a small average annualized outperformance.

Lee: You clearly believe in having a broad latticework of knowledge from different educational disciplines from which to draw upon when judging investment ideas. Can you describe how you spend your day? Do you devote a general percentage of your time to reading "non-investment" material versus 10-Ks, etc.?

Pabrai: My calendar is mostly empty. I try to have no more than one meeting a week. Beyond that, the way the day is spent is quite open. If I'm in the midst of drilling down on a stock, I might spend a few days just focused on reading documents related to that one business. Other times, I'm usually in the midst of some book, and part of the day goes to keeping up with correspondence -- mostly email.

I take a nap nearly every afternoon. There is a separate room with a bed in our offices. And I usually stay up late. So some reading, etc., is at night.

Lee: In Trade Like Warren Buffett, you mention that you let investment ideas come to you by reading a lot, and also monitoring familiar names on the NYSE. Can you describe your process of generating investment ideas -- is it simply just reading a lot? Do you do anything else to actively seek out ideas?

Pabrai: The No. 1 skill that a successful investor needs is patience. You need to let the game come to you. My steady-state modus operandi is to assume that I'm just a gentleman of leisure, and that I'm not in the investment business. If something looks so compelling that it screams out at me, saying "Buy me!!," I then do a drill-down. Otherwise, I'm just reading for reading's sake. So, I scan a few sources and usually can find something scream out at me a few times a year. These sources (in no particular order) are:

1. 52-Week Lows on the NYSE (published daily in The Wall Street Journal and weekly in Barron's)
2. Value Line (look at their various "bottoms lists" weekly)
3. Outstanding Investor Digest (www.oid.com)
4. Value Investor Insight (www.valueinvestorinsight.com)
5. Portfolio Reports (from the folks who put out OID)
6. The Wall Street Journal
7. Financial Times
8. Barron's
9. Forbes
10. Fortune
11. BusinessWeek
12. The Sunday New York Times
13. The Value Investors' Club (www.valueinvestorsclub.com)
14. Magic Formula (www.magicformulainvesting.com)
15. Guru Focus (www.gurufocus.com)

Between all of the above, I have historically found at least three to four good ideas every year. Sometimes I make a mistake, and a good idea turns out to be not so good.

Lee: A big part of investing is knowing what to pay attention to and what not to [focus on]. How do you sift through the thousands of investment ideas? Often, bargains are bargains because they're unrecognizable -- how do you spot the needles in the haystack, and how do you avoid the value traps?

Pabrai: I wait to hear the scream. "Buy me!" It needs to be really loud, as I'm a bit hard of hearing.

Lee: Would it be fair to say you are more balance sheet-oriented, versus income/cash flow statement-oriented? If so, how do you get comfortable with the asset values (i.e., Frontline, death care)?

Pabrai: John Burr Williams was the first to define intrinsic value in his The Theory of Investment Value, published in 1938. Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows -- discounted at an appropriate interest rate -- that can be expected to occur during the remaining life of the business. The definition is painfully simple.

So, cash can be gotten out of a business in a liquidation or by cash the business generates year after year. It is all a question of what is the likelihood of each. If future cash flows are easy to figure out and are high-probability events, then liquidation value can be set aside. On the other hand, sometimes the only thing that is a high probability of value is liquidation value. Both work. Depends on the situation. But you first need to hear a scream ...

A worthy successor
Pabrai's answers have provided a great look into the thoughts and habits of an excellent value investor. In fact, he's one of a handful alive who are generally acknowledged as worthy of following in Buffett's footsteps (Pabrai was nominated as a "Buffetteer" by Forbes magazine). Like Buffett, Pabrai gives credence to the theory that activity shouldn't be confused with productivity, but instead tends to result in friction.

Be sure to tune in tomorrow, when we publish the second part of the interview and find out more about how to become a better investor.

For more interviews with other hedge fund managers, check out:


Pabrai Investment Funds Annual Meeting Notes

September-28-2010

Pabrai Funds Annual Meeting
Chicago Illinois
September 25th 2010

Prepared Comments:

The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.

$100,000 invested in the fund in June of 2000 would be $408,000 today.

Mohnish's goal is to beat the index by 3% annually.

This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.

The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.

Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.

Mohnish then went through one winner and one loser in the portfolio.

The worst investment during the period was Ternium which was actually sold at a small gain.

The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren't able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.

Question and Answer:

How Long did you follow Teck Cominco before buying?

Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.

Thoughts on Fairfax?

He doesn't discuss current holdings.

Why don't you discuss current holdings?


If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.

What are your views on position sizing?

His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it's very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.

What attracts you to a business?

When he finds a company that looks interesting he starts by thinking as a skeptic. He looks for something that will prove him wrong. He looks for areas of extreme mispricing. It has to be very undervalued but he also has to be able to understand it. He thinks there may be value in Coke bottlers in Japan. The Nikkei has done nothing for 27 years.

Has the increasing size of the fund negatively affect performance?

The performance of the fund has not been affected by size or fund inflows. He said that the fund is sitting on a lot of undervalue assets.

Has the economic turmoil changed your model?

Mohnish said he has more of an appreciation for macro issues than he has in the past. He also said that some macro trends make sense to base investments on. But the majority of macros trends such as inflation and interest rates are very difficult to predict and he doesn't make judgments on those.

What are your thoughts on the financial industry?

Understanding management is key. You want to look for competent and honest managers. Because of the high leverage, management cannot make any mistakes in reserving. Also, it's very difficult for outsiders to understand reserving. He couldn't understand Citibank.

How much time do you spend on the balance sheet of companies you invest in?

Before he invested in Teck Cominco he read the last 8 years of annual reports. He spends a lot of time on the balance sheet.

What's your philosophy on timing buying and selling?

He expects to be wrong in the future on selling. He said its fine to sell to early. If a stock goes down after he buys it that's fine as long as he is still right about intrinsic value and he has dry powder to invest.

What did you identify with the checklist project?

The mistakes were concentrated in 08-09 and included a lot of financials. A lot of the mistakes were similar so he just picked a few. He analyzed Longleaf's investment in GM. Longleaf's management discussed the GM thesis in its reports. The mistake they made was they missed the forest from the trees. They missed the big picture. They figured that because GM did so well in the truck market that that would carry them through. They missed the fact that gas prices would rise to $3. He also said that he greatly respects these managers but that it's important to learn from them. Longleaf also made the mistake of looking at the wrong variables.

How do you know where the edge of your circle of competence is?

If you have to ask yourself that question when looking at a company, then it's probably beyond your circle of competence. You have to be honest with yourself. In the case of the Japanese companies he is researching, he has no interest in American listed Japanese companies. He will use the basket approach to Japanese companies because of the unfamiliarity. He also said that these Japanese companies are extremely cheap.

A business owner in the audience said after analyzing his own mistakes he noticed many of his mistakes were repeated. He asked if Mohnish had made a mistake more than once and was susceptible to reoccurring mistakes in one area?

Chris Davis wrote about a mistake he made in 2002. He ended up making the same mistake again in 2008 with AIG. Buffett made the same mistake twice as well with the original Berkshire Hathaway purchased and later on, with the Dexter Shoe purchase. Leverage is a very important factor to consider. One item on the check list is whether or not he suffers from any personal biases. The checklist forces him to take a step back.

Do you see any bubbles today?

Bubbles are hard to spot. Real estate in certain parts of China is probably a bubble. There are many bubbles around all the time. He mentioned a book called Trendwatching.

What's your philosophy on investing in foreign markets?

He said that investing in US and Canadian companies that are driven by Chinese factors would be of interest to him. It's important to understand foreign growth. You have to watch out for bubbles. China and India have good prospects but there may be an overall bubble. He's very reluctant to invest in China but he's interested in benefiting from Chinese growth. He skips Chinese companies because of accounting.

What does he think about natural gas companies?

The industry may be subject to a disruptive shift because of technological changes. The low prices may be permanent but he has no idea. The only good way to invest would be at the bottom of the cost curve and he can't find one. There is no choke point in natural gas unlike iron ore. Natural gas also has substitutes. Mohnish recommended the book, Irrational Optimist. He talked about how cheap energy allows countries to create more fresh water which will allow more agriculture.

How do you prevent macro issues from blinding investments?

He's learned to appreciate macro issues more than in the past. As an investor you can't get a handle on all factors. So it makes sense to spread ideas out more. The micro factors trump the macro factors. The company has to be able to control its destiny. He looks for staying power so the company can withstand shocks.

This question came from an investor who has to pull out money for living expenses. He asked how he can get more visibility on what taxes will be?

Mohnish practices tax planning in the funds. He sells holdings between the funds to cancel capital gains. The statements sent to shareholders should give them a good idea what the expected tax rate will be. Mohnish is a big tax payer so he is very sensitive to tax issues.

Is your philosophy on portfolio allocation shifting more towards preserving wealth instead of growing it?

The Kelly Formula is only correct when making many bets. He always under bet the Kelly Formula. Since Mohnish is making few bets, the Kelly Formula doesn't work. He never fully used the Kelly Formula because it would have told him to bet more heavily. Return of capital is more important than return on capital. If people redeem their money during down times that is permanently lost capital for those people.

Can you name some great companies that you'd love to own at the right price?

Ikea, In and Out Burger, Costco, the low cost mines owned by BHP and Rio Tinto. Great companies are all over the place across the world. There are great companies in India and China but and ownership issues exists over there. Pricing is also an issue. Ben Graham's approach was to go to the store and buy what was on sale and Charlie Munger's approach is to go to the store and wait for quality items to go on sale. He likes Charlie's framework.

What extra work do you do to analyze financials?

He's reluctant to own most financials. They do own Goldman Sachs. He's read two books on Goldman. It's a great business. He doesn't have a problem with management ethos but it's improving. It's a very complex business. They have the potential to grow huge overseas because they have few offices overseas right now. Since it has opaque parts to its business he made it a basket bet.

Does checklist address good portfolio strategies?

No. The checklist deals with analyzing companies. Mohnish recommended that this person read the fundamental value investing books. Mohnish always tries to learn from others.

Would you be more interested in a more certain intrinsic value or a cheaper price?

Currently the fund holds a lot of cash as there is less cash in the fund he demands higher discounts for new investments. I wasn't able to too write down most of his answer.

What's your average cash level since 1999?

In a crisis, cash plus courage is priceless. Next times a crisis strikes, he wants more cash. Instead of jumping from his second best to his best idea he instead lets investments play out and clings to ideas instead of jumping around.

How does Mohnish spend his free time?

He does plenty of other things. He has a daily nap, plays racquetball and plays bridge.
Discuss this story

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My $650,100 Lunch with Warren Buffett

What would you pay to have lunch with the richest man in the world? For me and Mohnish Pabrai — a friend who, like me, runs a U.S.-based investment fund — the answer is $650,100. That's how much we forked out for the privilege of dining with Warren Buffett on June 25.

It was worth every dime. Buffett is the most successful investor in history, yet he has reached that pinnacle while also being supremely ethical. As remarkable for his philanthropy as for his stock-picking, he's giving the bulk of his billions to the Bill & Melinda Gates Foundation; likewise, the fee for our lunch would go to the Glide Foundation, which helps the poor and homeless. Lunch with Buffett, we figured, would be a good way to give to charity, but it would also be the ultimate capitalist master class — a chance to see up close what makes the Sage of Omaha tick and to learn from his wisdom.

And so it was that my wife and I sat down for lunch with Buffett in a cozy, wood-paneled alcove of the Manhattan steakhouse Smith & Wollensky. Mohnish brought along his wife and two daughters, who sat on either side of Buffett. When the menus arrived, Buffett, now 77 years old, joked with the girls that he doesn't eat anything he wouldn't touch when he was less than 5. His order: a medium-rare steak with hash browns and a cherry coke — a fitting choice, given that his company, Berkshire Hathaway, is Coca-Cola's largest shareholder.

Characteristically, Buffett had done his homework: he'd found out in advance, for example, that my wife was born in Salisbury, North Carolina. But after a minimum of small talk to put us at ease, it was down to more serious matters. When I mentioned how difficult I'd recently found it to do the right thing by lowering the fees I charged my fund's shareholders, Buffett nodded sympathetically and observed, "People will always try to stop you doing the right thing if it is unconventional." When I asked if it would get any easier, he replied with a wry smile: "Just a little."

Buffett has made a point of doing business with integrity — and of working only with people who share his values. As we learned, he credits his father with teaching him early on to rely on his own sense of what's right, rather than looking for affirmation from others. "It's very important to live your life by an internal yardstick," he told us, noting that one way to gauge whether or not you do so is to ask the following question: "Would you rather be considered the best lover in the world and know privately that you're the worst — or would you prefer to know privately that you're the best lover in the world, but be considered the worst?"

When it comes to investing, nothing is more important than the ability to think rationally for oneself — and Buffett is unsurpassed on this front. In the late '90s, he was criticized for his refusal to invest in booming tech and Internet stocks — a decision that was vindicated when the bubble burst. Buffett has made a fine art of keeping this kind of distracting noise at bay: he said he even limits his contact with managers of businesses in which he invests, preferring to assess their companies' financial records — a more neutral source of information. Equally vital to his success, Buffett said he focuses only on investments that lie well within his "circle of competence." As a result, he confided, whenever he makes an investment, he has no doubt at all that he's right.

For most people, attaining the intellectual clarity and emotional detachment that investing requires is tough. But Buffett, for all his affability, is shrewd about disengaging himself to avoid any unnecessary distractions that might impair his judgment. People often try to convince him to meet with them so they can pitch investments to him, he said, but he sees through their many ruses — not least their flattery — and is comfortable saying no far more often than he says yes.

One thing Buffett wasn't about to say no to was dessert. He delighted in sampling an array of them, telling the waiter: "Just bring a couple of spoons, and I'll have a little of everyone's." His zest for life is clearly undiminished — indeed, in Berkshire's latest annual report, he wrote that he and his octogenarian partner Charlie Munger "tap-dance to work."

What better role model could you ask for than this? And how do you put a price on the opportunity to spend nearly three hours in his company? Well, two days after our meal, the auction closed on eBay for next year's lunch with Buffett. The winner, a Chinese money manager named Zhao Danyang, bid $2.1 million. So, that proves it: our $650,100 lunch was a total bargain.

Guy Spier is CEO of Aquamarine Capital Management


Pabrai Investment Funds Annual Meeting Notes

I attended the Pabrai Investment Funds annual meeting in Chicago last Saturday. Mohnish did a great job answering questions, as usual. I've been lucky enough to get to know Mohnish over the past few years. Mohnish is one of the best fund managers in the country. He is one of the most genuine people I know and like Buffett he is always enjoying his job and cracking jokes.

Here are my notes from the 2010 Pabrai Investment Funds Annual Meeting in Chicago:

Prepared Comments:

The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.

$100,000 invested in the fund in June of 2000 would be $408,000 today.

Mohnish's goal is to beat the index by 3% annually.

This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.

The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.

Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.

Mohnish then went through one winner and one loser in the portfolio.

The worst investment during the period was Ternium which was actually sold at a small gain.

The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren't able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.


Question and Answer:



How Long did you follow Teck Cominco before buying?

Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.

Thoughts on Fairfax?

He doesn't discuss current holdings.

Why don't you discuss current holdings?

If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.

What are your views on position sizing?

His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it's very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.

What attracts you to a business?

When he finds a company that looks interesting he starts by thinking as a skeptic. He looks for something that will prove him wrong. He looks for areas of extreme mispricing. It has to be very undervalued but he also has to be able to understand it. He thinks there may be value in Coke bottlers in Japan. The Nikkei has done nothing for 27 years.

Has the increasing size of the fund negatively affect performance?

The performance of the fund has not been affected by size or fund inflows. He said that the fund is sitting on a lot of undervalue assets.

Has the economic turmoil changed your model?

Mohnish said he has more of an appreciation for macro issues than he has in the past. He also said that some macro trends make sense to base investments on. But the majority of macros trends such as inflation and interest rates are very difficult to predict and he doesn't make judgments on those.

What are your thoughts on the financial industry?

Understanding management is key. You want to look for competent and honest managers. Because of the high leverage, management cannot make any mistakes in reserving. Also, it's very difficult for outsiders to understand reserving. He couldn't understand Citibank.

How much time do you spend on the balance sheet of companies you invest in?

Before he invested in Teck Cominco he read the last 8 years of annual reports. He spends a lot of time on the balance sheet.

What's your philosophy on timing buying and selling?

He expects to be wrong in the future on selling. He said its fine to sell to early. If a stock goes down after he buys it that's fine as long as he is still right about intrinsic value and he has dry powder to invest.

What did you identify with the checklist project?

The mistakes were concentrated in 08-09 and included a lot of financials. A lot of the mistakes were similar so he just picked a few. He analyzed Longleaf's investment in GM. Longleaf's management discussed the GM thesis in its reports. The mistake they made was they missed the forest from the trees. They missed the big picture. They figured that because GM did so well in the truck market that that would carry them through. They missed the fact that gas prices would rise to $3. He also said that he greatly respects these managers but that it's important to learn from them. Longleaf also made the mistake of looking at the wrong variables.

How do you know where the edge of your circle of competence is?

If you have to ask yourself that question when looking at a company, then it's probably beyond your circle of competence. You have to be honest with yourself. In the case of the Japanese companies he is researching, he has no interest in American listed Japanese companies. He will use the basket approach to Japanese companies because of the unfamiliarity. He also said that these Japanese companies are extremely cheap.

A business owner in the audience said after analyzing his own mistakes he noticed many of his mistakes were repeated. He asked if Mohnish had made a mistake more than once and was susceptible to reoccurring mistakes in one area?

Chris Davis wrote about a mistake he made in 2002. He ended up making the same mistake again in 2008 with AIG. Buffett made the same mistake twice as well with the original Berkshire Hathaway purchased and later on, with the Dexter Shoe purchase. Leverage is a very important factor to consider. One item on the check list is whether or not he suffers from any personal biases. The checklist forces him to take a step back.

Do you see any bubbles today?

Bubbles are hard to spot. Real estate in certain parts of China is probably a bubble. There are many bubbles around all the time. He mentioned a book called Trendwatching.

What's your philosophy on investing in foreign markets?

He said that investing in US and Canadian companies that are driven by Chinese factors would be of interest to him. It's important to understand foreign growth. You have to watch out for bubbles. China and India have good prospects but there may be an overall bubble. He's very reluctant to invest in China but he's interested in benefiting from Chinese growth. He skips Chinese companies because of accounting.

What does he think about natural gas companies?

The industry may be subject to a disruptive shift because of technological changes. The low prices may be permanent but he has no idea. The only good way to invest would be at the bottom of the cost curve and he can't find one. There is no choke point in natural gas unlike iron ore. Natural gas also has substitutes. Mohnish recommended the book, Rational Optimist. He talked about how cheap energy allows countries to create more fresh water which will allow more agriculture.

How do you prevent macro issues from blinding investments?

He's learned to appreciate macro issues more than in the past. As an investor you can't get a handle on all factors. So it makes sense to spread ideas out more. The micro factors trump the macro factors. The company has to be able to control its destiny. He looks for staying power so the company can withstand shocks.

This question came from an investor who has to pull out money for living expenses. He asked how he can get more visibility on what taxes will be?

Mohnish practices tax planning in the funds. He sells holdings between the funds to cancel capital gains. The statements sent to shareholders should give them a good idea what the expected tax rate will be. Mohnish is a big tax payer so he is very sensitive to tax issues.

Is your philosophy on portfolio allocation shifting more towards preserving wealth instead of growing it?

The Kelly Formula is only correct when making many bets. He always under bet the Kelly Formula. Since Mohnish is making few bets, the Kelly Formula doesn't work. He never fully used the Kelly Formula because it would have told him to bet more heavily. Return of capital is more important than return on capital. If people redeem their money during down times that is permanently lost capital for those people.

Can you name some great companies that you'd love to own at the right price?

Ikea, In and Out Burger, Costco, the low cost mines owned by BHP and Rio Tinto. Great companies are all over the place across the world. There are great companies in India and China but and ownership issues exists over there. Pricing is also an issue. Ben Graham's approach was to go to the store and buy what was on sale and Charlie Munger's approach is to go to the store and wait for quality items to go on sale. He likes Charlie's framework.

What extra work do you do to analyze financials?

He's reluctant to own most financials. They do own Goldman Sachs. He's read two books on Goldman. It's a great business. He doesn't have a problem with management ethos but it's improving. It's a very complex business. They have the potential to grow huge overseas because they have few offices overseas right now. Since it has opaque parts to its business he made it a basket bet.

Does checklist address good portfolio strategies?

No. The checklist deals with analyzing companies. Mohnish recommended that this person read the fundamental value investing books. Mohnish always tries to learn from others.

Would you be more interested in a more certain intrinsic value or a cheaper price?

Currently the fund holds a lot of cash as there is less cash in the fund he demands higher discounts for new investments. I wasn't able to too write down most of his answer.

What's your average cash level since 1999?

In a crisis, cash plus courage is priceless. Next times a crisis strikes, he wants more cash. Instead of jumping from his second best to his best idea he instead lets investments play out and clings to ideas instead of jumping around.

How does Mohnish spend his free time?

He does plenty of other things. He has a daily nap, plays racquetball and plays bridge.


http://www.forbes.com/forbes/2004/0607/154_print.html

There is only one Warren Buffett but many who profess to be his disciples. Here are three stock pickers trying to beat the money master at his own game.

 
Berkshire Hathaway Chairman Warren Buffett
 
The Berkshire Hathaway annual meeting takes over Omaha every spring with the force of a Hell's Angels rally. The cheapest tickets cost $3,000, the price of a Berkshire Hathaway B share. This year's hoopla drew 19,500 shareholders eager to glean advice from the investment sage. Alas, Buffett's musings are philosophical and historical; he doesn't give stock tips.

That doesn't stop Buffett fans from trying to imitate him. They may ape his stock purchases once Berkshire's holdings become public. Or they may apply his style of value management to the selection of other stocks. But nobody else's stock-picking record comes close to Buffett's in both cumulative percentage gain and dollar magnitude. Berkshire shares were worth $15 apiece when he took over the company 39 years ago; now they go for $85,500, and the company's market value is $131 billion. In recent years, however, the performance engine has lost some steam, and some imitation Buffetts are doing better than the real thing.

The Sincerest Form of Flattery
Two beat Warren, one tied. The oldest fund lags: Sequoia, closed to new money.
    ANNUALIZED RETURN  
Fund Inception
date
since
inception
in Berkshire Hathaway
since fund's inception
Minimum
initial
investment
Expenses
per $100

Fairholme 12/29/99 18.1% 13.9% $2,500 $1.00

Pabrai 7/1/99 35.3 14.2 100,000 -*

Sequoia 7/15/70 16.5 26.3 closed 1.00

Wisdom** 2/16/99 5.2 5.2 2,500 1.50

Prices as of Apr. 30, except Pabrai, as of Mar. 31. *Fund charges 25% of profits after 6% return. **Has maximum 5.75% front-end sales charge. Sources: Lipper; FT Interactive Data via FactSet Research Systems; Pabrai Investment Funds.





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The Asset-Watcher


Mohnish Pabrai stays closer to Buffett's mentor, Ben Graham, than Buffett himself does these days.


High fees make this magazine skeptical of hedge funds but don't stop us from admiring their stock-selection skills. Los Angeles hedge fund manager Mohnish Pabrai, 39, seems to have some talent as a stock picker. Since he started Pabrai Investment Funds in 1999, he has delivered a 35.3% compound annual return (after fees), to the 14.2% a year you would have made owning Berkshire shares.


 •Investment Guide

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 •Guide To Deducting Losses
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 •Investing In Thoroughbreds
There are two reasons the $116 million portfolio has done better than the competition in Omaha. One, says Pabrai, is that he doesn't try to emulate Berkshire's holdings in wholly owned subsidiaries. That has kept him out of property/casualty insurance, which accounts for a big part of Berkshire's revenue and had suffered some setbacks (such as claims from Sept. 11). The other is that he hews a little more closely to the kind of value investing espoused by Buffett's mentor, Benjamin Graham. Graham liked to buy companies for less than net current assets, meaning cash, inventory and receivables minus all obligations. Buffett has pushed the definition of intrinsic value in new directions. He is willing to pay for intangibles, like a consumer brand name or a newspaper monopoly, provided those assets throw off "owner's profits"--cash that can be extracted from a business after necessary capital outlays are paid for.


Like Buffett, Pabrai keeps his distance from Wall Street. He buys no research and has no hired help. If he can't understand a company, he doesn't buy the stock. Further, Pabrai won't meet with a company's executives; if he socializes with one, he'll never invest in the stock. "Chief executives are salesmen, as Graham says," Pabrai intones. "That's how they get their jobs."

Pabrai last year bought the Norwegian oil tanker firm Frontline when shipping rates fell to $5,000 a day. To remain profitable, the company needs rates of at least $18,000 a day on its 70 double-hulled oil tankers. Investors fled the stock, and it fell to $3. Frontline wasn't a classic Graham value play since it didn't have much in the way of net current assets. But it did have hard assets--those tankers.

After noticing the stock on a new lows list, Pabrai looked into the oil shipping business and discovered that small Greek shippers with near-obsolete single-hulled tankers were being hurt more than Frontline and were selling their ships for scrap. So he knew that when oil demand next surged, Frontline would be better able to command premium rates. Near the end of 2003 Frontline was charging $50,000 a day per tanker. Pabrai is long gone, but the stock, at $29 a share, trades at a cheap five times trailing earnings.

In 2002 he beat Buffett to the convertible bonds of Level 3 Communications. Like his hero, Pabrai saw value in telecom's distress.



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Poll: Where Will The Stock Market Be Next Year?

The Copycat

C. Douglas Davenport, manager of the $52 million Wisdom Fund in Atlanta, is Buffett's shadow. If Buffett does something, Davenport will, too--going so far as to buy proxy stocks for companies that Berkshire acquires. Davenport keeps the identical proportion of cash that Berkshire does, a sizable 22% of his portfolio.

Davenport's fund, with backing from Sir John Templeton's family, started in early 1999 as the Berkshire Fund but changed its name after the real Berkshire complained. Davenport, 53, follows Berkshire's public filings and news reports to see what Buffett has been up to. "Buffett is quite well followed. It's amazing how much you can find out about the man on the Internet," he says. Thus Davenport has 8% of his assets in Coca-Cola, and 4% in American Express, just like Berkshire.

When Berkshire acquired carpetmaker Shaw Industries in 2001, Davenport went after competitor Mohawk Industries, waiting two weeks for its share price to settle down. Last year Berkshire bought Clayton Homes, a builder of prefab homes, and Davenport bought into similar Champion Enterprises. To roughly match Berkshire's huge stakes in auto insurance and reinsurance, Davenport has American International Group.

Since inception just over five years ago Wisdom is up an annual 5.2%, after its 1.5% expense ratio, matching Berkshire's showing.



 •Investing Like Warren Buffett  •20 Stocks For The Long Haul  •Condos With Room Service  •Buying College Admission


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In Pictures:
Five-Star Living
Investing In Your Child's Future
Video: Prospering In Trying Times
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Berkshire With Special Sauce

The Fairholme Fund, managed in Short Hills, N.J. by Bruce Berkowitz, Larry S. Pitkowsky and Keith Trauner, has a fourth of its $130 million in Berkshire shares. But it has done better with its non-Berkshire holdings. Net of 1% in overhead, Fairholme has returned 18.1% a year since its inception in 2000, besting Berkshire's 13.9%.

The fund's second-largest holding is Leucadia National, a Berkshire-like conglomerate run by recent Buffett partners Joseph Steinberg and Ian Cumming. Alongside Buffett, Fairholme invested in White Mountains Insurance Group, holding on even after the Sept. 11 attacks, when insurance stocks looked dicey. Fairholme makes bets on distressed companies that would scare off a classic Grahamite. In 2002 it started buying debt of troubled Williams Communications, saw that debt converted to equity in a reorganization and bought more equity. When Leucadia acquired the business last year, Fairholme's stake appreciated 50%.