Dhandho. Heads I win | Mohnish Pabrai | Talks at Google

1. 0:02 – 2:00

   Welcome and framing: asymmetric bets with limited downside

   1. SPSpeaker0:02

      Welcome everyone. Uh, anyone who's read an annual letter of Berkshire Hathaway has often come away marveling at Warren Buffett's ability to distill complex, uh, concepts into very intuitive language. Our speaker for today, Mohnish Pabrai, is someone who paid six hundred and fifty thousand dollars for a lunch with Warren Buffett in 2007. It's a sum he calls a bargain. And in the same spirit as Warren Buffett and Charlie Munger, he has a very intuitive, very evocative, very emotionally appealing way of distilling complex concepts into his form of connecting with the audience. He's, he, he's probably a fantastic teacher, although he ca- does not carry that official title, uh, if you go by any of his presentations to various university groups. Our speaker from last time, Michael Mauboussin, spoke about the role of luck and skill in life. He spoke about how there is not often a linear cause and effect chain, but a spectrum of probabilistic outcomes in life. Mohnish takes that one step further. He talks about being preferential towards probabilistic scenarios where you have a limited downside, but a disproportionately high upside. Also, I could go on and on about, you know, his investing philosophy, his philanthropic, uh, activities, so on and so forth. But I think what we'll see here is how he really cares about connecting with the audience and how good of a teacher he is. So without further ado, further ado, ladies and gentlemen, please join me in welcoming Mohnish Pabrai. [audience applauding]

2. 2:00 – 3:31

   Pabrai’s opening: Google as a potentially “future-proof” company

   1. MPMohnish Pabrai2:00

      Thank you. Uh, thank you, Saurabh. It's a wonderful, warm welcome. Very much appreciate it. And, uh, you know, it was pretty exciting for me when, uh, uh, when we got the email from Saurabh about, uh, the possibility of speaking at Google because, uh, uh, it's easy to be a fan. Uh, and I think it's, uh, it's a wonderful company. In fact, I, I think in many ways, in the end, uh, when we look back, I think Google might very well be the, the greatest company ever created and, uh, for a variety of reasons. And, uh, one of your, uh, one of your board members, uh, he's not a friend, he's an acquaintance of mine. And, uh, I'd asked him a few years back, you know, "So what's the next Google?" And, um, his response, he instantly said, he said, "The next Google is Google." And I think that's a, that's a great reply because I think it's the way the company is designed. Um, you know, Warren Buffett always says that, uh, um, investing in businesses with rapid change are the enemy of the invest- investor. Um, in many ways, you know, Google is kind of future-proof from that vantage point just because of the way it's structured. And so it's, uh, quite exciting, uh, to be outside the plex and look in and, uh, see all the great stuff going on. So anyway, from, uh, a number of perspectives,

3. 3:31 – 6:02

   What “Dhandho” means: business with upside and minimal downside

   1. MPMohnish Pabrai3:31

      I'm, I'm delighted to be here and, um, uh, always kick myself for never investing in Google stock. But there's still time, and we might still get there one day, so we'll see. Um, so The, The Dhandho Investor, uh, you know, the book that, um, came out a few years back, uh... Buffett, Buffett has a quote. He says, "I'm a better investor because I'm a businessman, and I'm a better businessman because I'm an investor." And, uh, in essence, that book, uh, The Dhandho Investor, is the expansion of that one sentence into 100-plus pages, um, uh, basically, you know, kind of delving into that particular nuance. And, um, you know, the word, the word Dhandho is a Gujarati word. And, um, do we have any Gujaratis in the room? Oh, we have one. One Gujarati. All right. That's good. So, um, uh, people always think I'm from Gujarat in India, um, because I wrote a book called The Dhandho Investor, and I have to always correct them and say I'm not Gujarati. Uh, I had a roommate from, from, from Gujarat, and, um, and, uh, he, um, uh, when I was, when I was doing my undergraduate in engineering and he was also an engineering major, he used to disappear on weekends because all his, uh, family, extended family had all these motels and laundromats and gas stations and whatnot that they owned in the Carolinas. And then he'd come back on Sunday night, and he'd be bursting with all these stories about, uh, the new investments his family had made and all the kind of the economics of those investments. And then in the end, he would finish and say, "Mohnish, Dhandho!" And that was his way of saying that, uh, the, the literal translation of the word Dhandho means business. Uh, but the way the Gujaratis use it, what it means is it's a, it's a way of doing business where you basically have upside with almost a non-existent downside. And, um, which is the key to investing is, uh, like Buffett says, uh, "Rule number one, don't lose money, and rule number two, don't forget rule number one." And, um, so that was kind of the, um, the backdrop behind the title and the book. And, um- You

4. 6:02 – 10:37

   How Patels came to dominate U.S. motels through low-cost operations

   1. MPMohnish Pabrai6:02

      know, Indians make up about 1% of the population of the United States, a little over three million people. And, uh, the Patels who are from Gujarat, uh, are a much smaller portion of that three million. My guess is they would probably be, uh, less than one-fifth of 1% of the US population, well under, uh, half a million or so. And, um, and even though they're that small a portion, probably more than sixty percent of the motels in this country are under Patel ownership. And that's a stunning statistic, um, considering that, you know, forty years back, there were no Patels over here. So, you know, they went from basically a, a standing start to pretty much dominating, uh, this industry. And they've moved upmarket. So they used to be at the lowest end, the smallest ten, twenty, thirty-room type highway motels. And now they're, you know, they're buying the Marriotts and the Westins and the Hiltons and all of that. So they're kind of moving up the, up the chain. And, um, uh, they, they came to the United States as refugees, and most of them came from East Africa, from Uganda. And, uh, at the time, in the early '70s, uh, there was this dictator, Idi Amin, who came into power in Uga-Uganda. And the Patels actually had come to Uganda several decades, more than a hundred years before that. And they came as, mostly as indentured laborers. But over time, using their Dhandho techniques, they pretty much controlled large portions of the Ugandan economy. And, uh, Idi Amin was very pissed off about that. And his perspective was that, uh, Africa is for Africans. And so what he did is he, uh, pretty much, uh, nationalized all their assets and, uh, took over all their personal property and threw them out of the country. And, uh, so they were stateless, actually. They, they really had no, uh, state to go to. Uh, India was reeling from the Bangladesh, uh, war and all the refugees coming from Bangladesh, so India actually refused to take the Patels in as refugees. Uh, England took some. Uh, in the United States at that time, the Nixon administration, they were quite familiar with the issue and, uh, uh, they were sympathetic to the plight of the Patels, but they were limited. So they, they took in-- the United States took in a few thousand Patels. A few more thousand came to Canada. And, uh, most of these Patels who showed up in the US in the early '70s didn't have that much in the way of education. And the only money they could really carry with themselves was kind of whatever they could convert into gold quickly, a few thousand dollars. And, uh, so they li-- they, they landed up in the United States, and they really found that they had virtually no skills, uh, which were of use to most employers. You know, they had a heavy accent and, um, and really didn't have much in terms of skills. And, um, but they found that, uh, motels, um, buying motels was a great way to go. And the reason they thought that was that because, uh, a typical Patel family at the time could buy a ten or fifteen-room motel for, uh, well under a hundred thousand, maybe fifty to seventy-five thousand dollars. And, um, the family could live in one or two of those rooms. And because motels are labor-intensive, uh, they would pretty much fire all the, all the staff, and they, the family would do all the work. Uh, so laundry, cleaning rooms, watching the front desk, everything was done, uh, by different members of the family. And, uh, they, they became low-cost operators. They looked at every single facet of the business. And so once a motel came under Patel ownership, uh, two things happened. One is that their operating costs dropped. And, uh, because their operating costs were lower, they were able to charge lower rates and increase occupancy. And, uh, so typically the Patel-owned motel in a particular area would always do economically better in terms of cash flows than the other non-Patel-owned motels. And as soon as they had enough cash flow, they would buy the second motel and then the third motel, and they just keep levering them and buying them up. And, uh, we end up with the result, uh, where we are today, where, uh, um, they pretty

5. 10:37 – 12:08

   “Heads I win, tails I don’t lose much”: Dhandho as an investing principle

   1. MPMohnish Pabrai10:37

      much, uh, dominate the space. And, um, that aspect to the way they went about doing their business, uh, has a lot of correlation with investing because the whole Buffett sentence of, uh, being a b-good businessman is, is a great skill set to being a great investor. And, um, the particular facet that they followed was, uh, this notion that I call Heads I win, and Tails, I don't lose much. So if you looked at the economics of a Patel buying a motel, typically, you know, they would put five or ten thousand dollars down, and, uh, most of it was a bank loan. And, uh, if for some reason, uh, they were not able to manage the cash flows, you know, the banks really would prefer not to take the motel back for, for closing it. They would prefer to do, you know, what they, what they did recently in the financial crisis, extend and pretend. You know, keep the, keep the same guy running it and, you know, hope that things, uh, kind of improve. So either way, the end result was the Patels, even with high leverage, were unlikely to lose their properties, and they didn't. They, because they were, uh, smart operators, uh, they, they got nowhere near that, that mark. And after a few years, the banks actually wanted to lend to, uh, motels under Patel ownership because they saw the default rates and all that were markedly different than the rest of the population. And so that worked out, uh, quite well for them. And, um- You

6. 12:08 – 17:13

   Richard Branson and Virgin Atlantic: building upside with little downside

   1. MPMohnish Pabrai12:08

      know, there's this, um, there's this notion that, um, it's just the Patels, uh, that have this kind of, uh, tight-fisted way of operating and this heads I win, tails I don't lose much. But you know, it's, it's actually all-- is available to us anywhere we look, and you find it in all kinds of places. So for example, if you, um, uh, if you look at, uh, Richard Branson, uh, in England, who's as far away from the Patels as you can think of, and if you examine the way Branson runs his different businesses, uh, they're very much, uh, in sync with the, um, uh, the Patel model of operating with heads I win, tails I don't lose much. So, uh, so for example, um, you know, before the formation of, uh, Virgin Atlantic Airlines, uh, Branson used to be in the music business. You know, he was a publisher of, of music and, uh, these, uh, these different raw boy-- like Boy George and, uh, the Sex Pistols and so on were now some of the brands that he had, uh, he had brought up. And, um, so one day he goes to his, uh, partners and says that, uh, he wants to start an airline and, uh, he wants to basically fly between London and New York and, um, and that he thinks it's a great m-market to go into. So his, you know, his partners were quite floored. They said, "Look, um, we're doing very well in the music business. Uh, we know nothing about the airline business. You need a jumbo jet to get into the airline business, and that jumbo jet costs about two hundred million. Uh, we don't have two hundred million, and, uh, we don't know anything about the business." So he says, "Well, you know, someone sent me this business plan." And Branson was smart. He said that, you know, if, if an executive in the music business gets a business plan to start a, an airline flying between London and New York, you know that, that the business plan has gone to three hundred other places before that and got turned down at every place that knew anything about what, about the business. But his-- he was intrigued by the plan and he tried calling, uh, British Airways over the weekend to try to book some flights just to see what the customer service was like, and he couldn't get through. So he said, "Well, either there's so much business that there's enough there for a second player to come in or, uh, they're so bad that a second player can come in and do a better job. Either way, there's, there's room for that." And then his, uh, partners told him that, "Yeah, that's all fine, uh, Richard, but you know, we don't have the money, we don't have the jet. We don't have a jumbo jet. How are we gonna do this?" And so what he did is he called, um, two oh six five five five one two one two, which is the, um, operator in Seattle, to get the number for Boeing. And, um, they gave him the Boeing main phone number, and he called Boeing, and he said he wanted to speak to someone who, uh, leases jumbo jets, and they'd repeatedly hang up on him. And, um, and, uh, finally he got to some guy who would actually speak to him and he said, "Look, uh, we typically have one or two customers in each country. Uh, we know who they are. Uh, you're not one of the people we talk to in England. Goodbye." So he said, "No, no, listen, before you hang up, uh, do you have a old used jumbo that you'd lease to one of these customers if they came to you?" Uh, he said, "Well, you're not one of them, but yeah, if they came to us, we actually do have an old jumbo lying around." He said, "Oh, well, if, if these people came to you, what would it cost to lease that jumbo?" And, uh, so the guy mentioned, you know, the pricing and such. He said, "Would you do a short-term lease because the jumbo is just sitting there?" Uh, he said, "Yeah, we'd be, we'd be flexible with our customers." So he convinced, he convinced Boeing to lease him that jumbo because it was just sitting there. And, uh, and then, uh, in the airline business, you know, before the plane takes off, you sold all the tickets, so your revenue comes in before you've spent a dime, and then you pay for the fuel thirty days after the plane's landed. So it's, it's a, it's a negative cash flow business in the sense that you, you don't need even working capital. And so he, he went about advertising and, uh, got the, got the, uh, the staff hired and got everything going and got this airline off the ground. And if you, if you think about it, you know, if, if someone can start a business in a tightly regulated industry like aviation, uh, with very high CapEx needs, like needing these jumbos with no capital, um, then you can pretty much say you can do that in any business, right? And, and if you think about the way Branson set it up, uh, he had no downside because what would happen if the thing didn't work? He'd just return the airplane and

7. 17:13 – 21:50

   Google as the “ultimate Dhandho business”: many small bets with massive optionality

   1. MPMohnish Pabrai17:13

      it'd be a few thousand dollars in terms of, uh, tens of thousands or whatever. And his music business at that time was producing about three or four million dollars a year in cash flows, so they had more than enough money to kind of, uh, take care of any eventualities. And that's the nature of, of Dhandho, is that you're making these, uh, asymmetric bets. And one of the reasons why I think, uh, Google is such a fascinating and incredible place because, you know, I, I don't think S-Sergey or, or Larry ever thought about it in these terms, but Google, Google is the ultimate, ultimate Dhandho business. And, and the reason it's the ultimate Dhandho business is if you look at, like, for example, your self-driving cars. So the self-driving cars, you know, the real CapEx on that would come when you need to build large scale factories to produce, you know, millions of cars. It is not when you're doing the R&D for those cars or have a few prototypes and, uh, you know, put a few dozen engineers on it and that sort of thing. So, so if you think of the outflows or outlays Google has on the self-driven car, you know, I would bet you're probably spending more on food at-- on the campus than you're spending on the self-driven cars. And so it's an asymmetric bet, right? It's basically if it doesn't work, it has no impact, no impact on cash flows or anything. And if it does work, it's game changing. Same thing with Android. You know, a few years back, Android was a project like- The self-driven car is, and it moved from being one of those, you know, outlier, uh, out there projects to very much central and cash flow. And then even when you look at your, uh, your balloons with the internet access or all the different other, uh, uh, projects that you guys are working on it, basically, each one of those has the potential to be a game changer in terms of kind of where, where the world ends up. But none of those have, uh, costs associated with them that have, uh, anything to do with, you know, uh, threatening the re-- the, the company in any way, right? I mean, it's a, it's a rounding error in terms of the cash flows that the company produces. So the, the fact that the DNA of a place like Google is able to do things which are not in adjacent fields, um, it's, it's quite spectacular. And most other companies don't have the DNA, uh, to be able to do that. And my, my, my two cents looking from the outside is, uh, probably the only bus- other business I see that has the ability to do that is Amazon. And I think in the end, you will meet them head to head on a number of different fronts. Um, so, so that's why it's, it's just a, a great place to be. And, um, you know, the other, other notion I, I just wanted to talk briefly about is, um, is this notion of compounding. So can we play that video? We'll just play maybe a couple of minutes of this video, and then I'll just talk about it. [ on-hold music] Okay.

8. 21:50 – 25:22

   Compounding explained: the chessboard rice story and Buffett’s long runway

   1. MPMohnish Pabrai21:50

      So, uh, you know, the-- this notion about compounding, and, you know, you saw that slide with Einstein saying compounding is the eighth wonder of the world. Um, there was this, uh, guy who, uh, invented the game of chess, um, and the king was so excited about the game and became a addicted player that he told the inventor, "You can ask for anything you want and, you know, it'll, it'll be yours." And, uh, the inventor of the game of chess says that, "You know, I just want you to put one grain of rice on the first square of the chessboard and then put two grains of rice on the second square, and then keep doubling the grains of rice until you get to the sixty-fourth square, and that's all I want." And, you know, that, that emperor clearly was not smart enough to be employed by Google and, um, and he was mathematically challenged, so he basically got upset with this inventor, "I wanted to give you all these things, and this is all you want, a bunch of rice." So the guy said, "Yeah, that's all I want." So he tells his treasurer, you know, "Measure out the rice for him and get him out of my court." And, uh, after a week, when the treasurer was still not done, he asked him what the problem was. He said, "Well, you know, it took me a while to run the calculation, but we don't have the rice." In fact, he said that there's not enough rice in the kingdom or even on the planet to fulfill the request. And, um, the amount of rice, you know, it becomes, you know, two to the sixty-four minus one, um, which is a, you know, long Google-ish kind of number. Um, in today's dollars, it's about three hundred bill- uh, three hundred trillion. Um, and I think that is just about global GDP. Uh, actually global, uh, not global GDP, but global wealth. So if you took the wealth of every man, woman, and child on the planet, that would have brought me-- brought equal to the two to the sixty-four minus one grains of rice. And, um, so that's the power of compounding, right? It, it, it grows dramatically. And when I heard about Buffett for the first time in ninety-four, uh, you know, he had been compounding for about forty-four years at the time, from about nineteen fifty, uh, to ninety-four. And when I looked at the track record, uh, it dawned on me that he was moving basically to the next square in less than three years. You know, he had averaged for the first forty-four years about thirty-one percent a year. So if you, uh, if you compound at twenty-six percent a year, uh, your money doubles every three years. And of course, if you're doing, um, thirty-one percent, then, you know, you're going, uh, even faster. And, um, and so, um, so basically, uh- You know, that is, that is at the essence of the, of the genius of Buffett and Munger, is they absolutely understand the power of compounding, and they basically have gone at it with this very long runway, um, and such. And of course, if you look at it from nineteen fifty to two thousand and fourteen, it is no wonder that Buffett ends up as the richest guy on the planet. Because, you know, if you keep compounding, uh, that's what ends up happening. And, uh, so that's, that's the, the one of the important takeaways I took from, uh, the learnings, uh, from Buffett and Munger is that, um, you

9. 25:22 – 26:22

   A simple value approach to compounding: buy far below worth and wait

   1. MPMohnish Pabrai25:22

      know, you don't really need to do extraordinary things to get extraordinary results. Uh, if, if you can, if you can double, uh, your money every three years, um, then you know a few doubles starts adding some significant numbers. I mean, if you, if you start with a million dollars in thirty years, it becomes a billion. If you start with ten thousand, it becomes ten million. It's just incredible in terms of what happens. And the doubling every three years, uh, you know, my way of thinking of that was that if you buy a stock at less than half of what it's worth, and you just sit on it, um, and in two or three years it gets to being what it's worth, uh, lo and behold, you'll have your twenty, thirty percent, uh, annualized, and sometimes you might get it in a year, and sometimes you might have mistakes, and the blended result of all of that, um, ends up, uh, being where it is. And, um, so, uh, so I think, I think compounding is, um, is

10. 26:22 – 30:35

    Risk vs. uncertainty: why “low risk, high uncertainty” creates mispricing

    1. MPMohnish Pabrai26:22

       a very powerful notion, very much, uh, uh, in sync with, uh, with the whole Dhandho framework. And one other thing I wanted to mention is that, you know, just in the same kind of, uh, mindset of, um, of, of Google is that, uh, you know, the market gets confused between risk and uncertainty, and it kind of, uh, confuses one for the other. And risk and uncertainty are two very different things. And in general, uh, anytime you get to a situation where risk is low, uh, but uncertainty is high, in general, um, the odds are high that the stock in question or business in question will be mispriced, and it'll probably be underpriced. Um, so that, that combination of low risk and high uncertainty, uh, is a grow-- great combo. And the low risk means that your downside is limited. And you know, a good way to think about that is like, for example, um, when, uh, when Bill Gates, uh, started Microsoft, you know, people always think about these companies being formed as being highly risky ventures. But if you really analyze it, so when Gates started Microsoft, he did not have a net worth or assets or capital. So the, the fact that he was taking a high risk, well, there's no capital to lose, so you can't really have risk because of a loss of capital. Um, and if you think about the opportunity cost, so he had not yet finished his undergraduate degree. At that time, with, you know, the couple of years that he had spent at Harvard, his value in the job market was very low. So if he went out looking for jobs and such, the people would not be willing to pay him that much. And if the venture did not work, so he moves to New Mexico, starts Microsoft. And so if you think about the, the notion that Microsoft doesn't work, well, he goes back to Harvard, finishes an undergraduate degree, and now when he graduates, he's got interesting stuff on his resume, that what he did at, at, in New Mexico for a year. So any way you look at it, the startup of Microsoft was almost risk-free. But the uncertainty related to Microsoft was very high. Uh, it could have been that the company failed and whatever little money he had was gone, or it could be that he could have become the wealthiest human on the planet, which he did. And so it's a very wide range of outcomes, uh, that could have happened at that point. And, but the key thing was that, uh, the risk was low. And in fact, if you study non-venture-backed startups, uh, non-venture-backed startups like the Patels, uh, do not take risk. Uh, in fact, we repeatedly study businesses, uh, you know, there's, there's more than a million businesses that get started in the United States every year. Less than a thousand of them are venture-backed, maybe a couple of thousand. So ninety-nine plus percent of businesses that get formed in the United States are not venture-backed businesses. And most of them follow this low risk, high uncertainty, uh, principle when they get going, like the Patels. And, um, so, so it's important to keep in mind that, um, I think you can replace capital with creative thinking, uh, the way, the way, uh, Richard Branson did. Uh, and certainly for most businesses, you don't even need the capital. And certainly in, in a knowledge economy type business, uh, uh, capital actually becomes, uh, useless, if you will. So, um, you know, I can keep going, but I think with that, what I'd like to do is to really hear, hear from you and, uh, just see what you have in mind and, uh, maybe try to address, uh, questions or comments along those line, those lines. So open up for all of you to talk. So-

    2. SPSpeaker30:29

       Thank you so much, Mohnish.

    3. MPMohnish Pabrai30:30

       Sure.

    4. SPSpeaker30:31

       And we'll open up the floor for questions.

11. 30:35 – 34:06

    Q&A: engineers, uncertainty, and why he avoids spreadsheets

    1. SPSpeaker30:35

       I've heard phrases along the lines of, "Beware of geeks bearing spreadsheets," from people like Buffett.

    2. MPMohnish Pabrai30:41

       [laughs]

    3. SPSpeaker30:42

       Is there something specific that technically-minded people should be aware of with investing?

    4. MPMohnish Pabrai30:48

       I mean, I would say that, you know, there are, there are these, uh, what I just talked about, the issue with uncertainty, right? So normally, engineers want to see precision and, uh, and you've got to actually be, uh, open to things where, uh, you may not have all the answers. In fact, in fact, by definition, investing is a very uncertain exercise because, uh, you really-- what you really need to do is you need to extrapolate what the fut-future cash flows of a business are going to be and then, then bring them down to the present and then decide whether that works or not. And in many cases, in many businesses, I would say that there's probably nobody on the planet, including the founders of Google, who could tell you what Google's cash flows are gonna be five years from now. And, and so, uh, but, but for example, if you could put a floor on those cash flows, um, then that might give you a basis to invest because you would say, "Okay, I know what my downside is." And floor on cash flow is a lot easier than actually predicting the cash flows, right? And so if you can, with a high probability, uh, start putting floors on things. So I think the engineering mindset needs to change a bit. And, uh, to some extent, actually Google's done that. If you, if you look at your server farms, you know, you've, you've gone with unreliable hardware, uh, with high failure rates and all of that and to some extent unpredictable times and places when things can fail, but that's built into the engineering of the solution. And so you're able to accommodate a high degree of uncertainty on, uh... So you don't know, you don't know which server's gonna fail when, but I think statistically, you know how many will fail, and then you can kind of design around that. So I think as long as you can kind of, uh, deal with uncertainty with generally... And the second thing is that, um, um, you're probably best off never touching Excel.

    5. SPSpeaker32:42

       [laughs]

    6. MPMohnish Pabrai32:44

       Right? So Excel has nothing to do with investing. Um, and, uh, so that might be, you know, uh, heresy at Stanford Business School or something. But, uh, but, uh, the way, the way to really look at investing is that, um, when, when you look at, again, a business like s- uh, Google or Microsoft or Berkshire, you really have to put yourself in the shoes of the people running the business, and you have to ask yourself, how do they run the business? Do they run it through a set of spreadsheets, or how do they run it? And I, and I would bet that, uh, most of these businesses are run in a manner where the founders or CEOs are really looking at kind of three to five variables that dominate most of the-- their thinking and outcome and direction. And so as an investor, uh, you've got to hone in on those same variables. So if you can get to the same variables, if you're gonna invest in Microsoft, you can get to the same variables that Satya Nadella is using. And if you-- and Google, you get to the same variables that Larry and Sergey are using, then you're getting very close to, uh, trying to figure out what the business might do. And, and from there you can extrapolate whether it's underpriced or fairly priced and so on. So that's what I would suggest is avoid the use of spreadsheets and avoid precision thinking.

12. 34:06 – 39:05

    Q&A: examples of simple theses—funeral services and a steel contract situation

    1. SPSpeaker34:06

       Can you maybe give us an example, may not be current, where you've looked at a business, looked at an industry and said, uh, "I think if I wanna analyze this business, here are the three variables that I think are the most important"? It-- maybe a pres-- example from past would help to-

    2. MPMohnish Pabrai34:24

       So, uh, a business that I didn't invest in or-

    3. SPSpeaker34:27

       It could be-

    4. MPMohnish Pabrai34:28

       Yeah

    5. SPSpeaker34:28

       ... there's something you invested in and maybe walk us through-

    6. MPMohnish Pabrai34:30

       Sure

    7. SPSpeaker34:31

       ... here are the three variables I thought were most important and-

    8. MPMohnish Pabrai34:33

       Sure. Uh, no problem. I, uh, I think that's a good question. So a few years back, I think this is probably going back more than ten years, um, I, I invested in a, um, funeral services company. So, you know, um, like this, like, you know, the gurus say, "Don't invest in industries with rapid change." Um, uh, humans are very slow to change the way we deal with our dead. Uh, it takes, you know, a few centuries for that to change. There's a small trend, uh, towards cremations, uh, which you can kind of adjust for. Uh, but, but by and large, it's a pretty steady state, uh, situation, um, with cremations. And so, um, there were these two companies, uh, they had done a major roll-up of the funeral services companies. One was, uh, Stewart Enterprises, which is based in, uh, Louisiana, and the other was Service Corp. And, uh, what they had done is they had bought a whole bunch of mom-and-pop, um, funeral service operators, and a lot of it was bought with debt and some of it with stock. And so what ended up happening is, uh, these companies were very highly levered. And, uh, and then they got, um, so levered that their, uh, they started tripping covenants, uh, on their, um, on their, on their bank debt and such. And, uh, when I looked at the companies, um, I think when I look at Stewart Enterprises, um, it was trading at, uh, little less than two dollars a share, and the cash flows they was generating, uh, at the time were close to a dollar a share. And, um, it wa- it was fairly tight in terms of their, um, uh, servicing the debt and all of that, but they were still generating positive cash flow. But they had, uh, lots of assets, uh, which were not generating any cash, and they paid significant amounts for it. For example, they had bought, um, hundreds of funeral, uh, funeral homes in Europe, and collectively, they were making no money on those, um, and, and such. So, uh, I thought that a business like that, you know, trading at two times cash flows was, uh- Ultra cheap, uh, because I said, "You know, what I'll do is I'll just wait for two years, and then the amount we're paying for the business will just be there in, in cash." And, um, and what they started doing after we, after we made the investment is they, uh, they announced a sale of a large portion of the European businesses, which again was from a cash flow point of view had no impact. But they generated significant cash from that sale, and then they gradually were able to start to restructure some of their, uh, loans and interest rates and covenants and all of that. And, uh, in a few years, that stock was at about eight dollars a share. And, um, so that's an example of, you know, looking at something-- Um, there was another, another one I'd looked at. It was a steel company called, uh, IPSCO. And, uh, IPSCO had these long contracts, uh, to supply steel and, uh, if you looked at the present cash flows and the cash flows for the next two years, um... So I think they were, uh, they were trading at, uh, uh, about, about ninety dollars a share. They had about thirty dollars a share in cash, and the next two years of cash flows were equal to sixty dollars. And so if you just held it for two years, you would have the full ninety in cash, but you'd have the entire business. And it was very hard to tell after two years what would happen to margins and cash flows. Uh, there was high uncertainty on that front, but I really didn't care about that because I said, "We'll just hold it for two years." And of course, we got to two years. They actually got the ninety dollars in cash, and then, um, they still had the engine running, and I think we made a four X on that investment eventually. So, so there's, uh, there's different models and such that you can look at, but I would say the, the most important thing is that before you invest is, uh, you should be able to explain the thesis without a spreadsheet, uh, within four or five sentences. And typically, I write down those sentences before I invest, so that if you're having a conversation with someone, uh, you could very quickly explain, "Look, here's the reasons why, uh, this investment makes sense." So...

13. 39:05 – 59:34

    Q&A: traits of great investors, control vs. minority ownership, and catalysts

    1. SPSpeaker39:05

       What are the top five attributes of a successful investor that you think are-- And second unrelated question is that does your investment style changes when you have control over company versus you don't, you're just, uh, another stakeholder? And how that changes, and how is that important for investment point of view?

    2. MPMohnish Pabrai39:23

       Okay. Well, we'll see if we can get to five. [laughs] But, uh, well, I would say, uh, good traits or important traits for being a good investor, number one, uh, the single most important skill is patience. Uh, so I think the thing is that markets have, uh, kind of a, a way of deceiving us because, you know, when you turn on CNBC and you see all those flashing red and green lights and all that, it's inducing the brain to think that you need to act now, and you need to act immediately, where nothing could be further from the truth. Uh, you know, Buffett always talks about having this punch card, uh, where in a lifetime you make twenty punches, and each time you buy a stock, you punch it once. So in a lifetime, you'd make 20 investment decisions, which means that if you started investing at twenty and ended at eighty, every three years on average, you'd make one investment. Uh, and that is very hard for most people to do. And so the more you can slow down your investing and the more patient you can be-- So the, the issue is that the, the timescales over which companies go through change and such is very different from the timescale at which stock markets operate. And, uh, so you really have to not focus so much on the stock market and have a lot more focus on the nature of change in businesses and be willing to be in there for a while. And like I told you, for the compounding to work, uh, you don't need to double your money every three months. Uh, even if you double your money every three years or even every five years, uh, that's plenty because, you know, it's just a matter of how many doubles you can get and, and such. So patience is the number one skill set. Uh, the second I think important skill would be that if you have run a business before, it's a huge advantage because of the whole interplay between investing and, and running a business, because it's very important to be able to, uh, understand how a CEO thinks and the factors that they are primarily focused on thinking about when they're running the business. And that's hard to get to, uh, with, with spreadsheets and so on. And, um, I think another, another very important trait for successful investing is to stay within your circle of competence. Um, so I think Buffett always says that it's not the size of the circle that matters, but knowing its boundaries, it's absolutely critical. And, um, uh, you know, Charlie Munger talks about that-- He gives a couple examples. One is he says that, uh, if in a small town, uh, you bought the McDonald's franchise, you bought the Ford dealership-

    3. SPSpeaker42:20

       Gas station.

    4. MPMohnish Pabrai42:22

       Ford dealership. Gas station not so good. And [laughs] gas station, we leave for the Patels. Low cost operations. Okay, and then, uh, then you want the best, uh, class A office building, and you want the best residential building, right? So if you've got these four assets-- And you don't need to own them completely, you could own twenty percent of each of them, right? So his perspective was that if in Peoria, Illinois, you own these four assets, uh, and you just sat on them for your whole life, you would end up probably quite wealthy. And, uh, so if you think about it from a, you know, modern portfolio theory point of view, you would say, "Well, you're not diversified. Everything's in one geography," et cetera, et cetera. Yeah, but the odds I'd probably still work out. And in fact, he has a friend, uh, here in, uh, near Stanford, uh, John Arrillaga, who all he did was bought r-real estate within a mile of the Stanford campus. And, you know, I think Arrillaga's a billionaire.

    5. SPSpeaker43:17

       [laughs]

    6. MPMohnish Pabrai43:17

       And, uh, so you know, what is Arrillaga's circle of competence? You know, it's this small. So the size of the circle is not relevant. Uh, staying inside the circle is very fundamental. Uh, so I think circle of competence is a very important trait. Another important trait is, uh, uh, margin of safety, so you buy things for well less than what they're, uh, uh, what they're worth. And then, uh, I think the final piece would be that, uh, you know, what Ben Graham says, that you're not buying a piece of paper, you're buying a fraction of a business. So if I were to think about investing in Google, for example, the question I should ask myself is, "If my family had a trillion dollars, would I be happy putting four hundred and ten billion..." Is that what the market cap is right now? Four hundred and ten billion? Right. So if, if, uh, if I had a trillion dollars, would I be comfortable putting four hundred and ten billion into Google? And if the answer is no, then I shouldn't put $10 into Google, right? So the mindset-- You know, so many times when people say, "You know, uh, what do you think of Apple?" Uh, and they don't know the market cap of Apple. So my, my question is then, why are you talking to me about Apple? You don't even know what the company is for sale for, you know? So if, if, if, if the, if you, if you're going to invest, at a minimum, you've got to know what the entire business is selling for, and would you be willing to put 50, 60% of your total family assets, if you had that much, into that business? And, uh, if the answer is no, then, then don't go there, you know? And, uh, I would've will-been willing to do that at Stewart Enterprises, you know, at the pricing I was looking at and all that. Uh, in fact, what I would've done, I would've bought a whole bunch of the debt as well too, just to get total control over the situation, so. And, and then, you know, just sit on those cemeteries. That'd be fine. So-

    7. SPSpeaker45:11

       So-

    8. MPMohnish Pabrai45:11

       And then your second question was?

    9. SPSpeaker45:13

       If you have a control over a company which is not a control over company-

    10. MPMohnish Pabrai45:16

        Right

    11. SPSpeaker45:16

        ...should investors behave-

    12. MPMohnish Pabrai45:17

        Yeah, so control is overrated. So people tend to think that when they have control, they can sprinkle pixie dust-

    13. SPSpeaker45:25

        [laughs]

    14. MPMohnish Pabrai45:25

        ...and things will be great. And quite frankly, I think that, uh, uh, I don't think that's the case at all. I think that, uh, you know, there are businesses, um, like Amex or Coca-Cola or Google and so on, uh, which are such high quality businesses, um, that, you know, it's not so much the control issue, it's more an issue of, you know, did you enter at the right price and those sorts of things that matter a lot more, so.

    15. SPSpeaker45:53

        Buffett talk about the passion about, uh, about what you are doing, right? He-- Like I think it's-- like Warren Buffett doesn't really care about money. He loves, uh, what he's doing, right? Okay, like, uh, like, uh, do you think that's what you are doing now? Do you love what you are doing, and do you think that's really, really important? Another thing is that do you think like, uh, sometimes this may become an obsession? Because like, uh, from reading, uh, Snowball, I have the impression that like, uh, investing like become an obstacle of Warren Buffett's, uh, family life, right? Like, uh, how do you adjust that? Yeah.

    16. MPMohnish Pabrai46:29

        Right. I mean, I, I would say that, uh, my, my take is that, uh, Buffett is a very aligned individual, um, in the sense that he's absolutely pursuing what he loves to do. Uh, you know, he would, he would be bored out of his mind if you sent him, uh, fishing forever or for them, for them golfing, or just asked him to, you know, do all these other things, you know, uh, which he has no interest in doing. So I, I think that he, he loves the game of investing. He loves more than investing, he loves actually buying entire businesses. Uh, so he's absolutely aligned on that front. And, uh, y-you know, uh, the thing is, uh, you can, um, you can, I think, optimize on some variables. So if you look at a person like Gandhi, uh, Gandhi's son became a male prostitute, okay? And in fact, Gandhi neglected his kids. So there could be an entire debate we could have on whether Gandhi had, uh, done the right thing or done the wrong thing. But that-- So to some extent, I think the thing is that we are human, and it may well be that a person like Gandhi could not have optimized on both fronts. You have the same issue with Nelson Mandela, right? So if you look at Nelson Mandela's personal life, there's all kinds of issues going on with the, with the spouse and so on. And, uh, in Buffett's personal life, you had-- Uh, in fact, in, uh, you know, I always tell my wife that, uh, uh, Warren, uh, was given a mistress by his wife. And I tell my wife that so that she's aware that that's an option.

    17. SPSpeaker48:10

        [laughs]

    18. MPMohnish Pabrai48:11

        And, uh [laughs] and so far she's not pulled the trigger on that option.

    19. SPSpeaker48:16

        [laughs]

    20. MPMohnish Pabrai48:17

        Uh, but you know, there's still time. And, uh, so, uh, uh, so my take is that, uh, I think there are many good, there are many good traits of Warren Buffett that have nothing to do with investing. I, I actually admire the way he even raised his kids and, and so on. But I think that, uh, what we are probably best off doing when we look at these, you know, kind of iconic figures, is not, not focus on so much the kind of minutiae, because you're gonna find things in the closet, um, that, that will make your skin crawl. Uh, but I think look at the bigger picture and say, you know, "What can we take from there that can, uh, that can be useful?"

    21. SPSpeaker49:01

        So, uh, I noticed that you haven't talk about the, the, uh, importance of the catalyst. Uh, I mean, the catalyst for, uh, the, uh, correction of the undervaluation of, uh, uh, financial assets such as, uh, stock. Um, uh, neither, uh, does, uh, Warren Buffett or Munger talks about, uh, talks a lot about it. But some other, uh, value investors like, uh, uh, maybe Seth Klarman, they, uh, they insist that, um, the, uh, catalyst is very important for a, for a, uh, for a bet on the undervalue stock. Uh, for example, that, uh, I sometimes, uh, experience, um, uh, buying a stock at, uh, at a very low valuation, such as maybe below the, uh, liquidation value, and maybe just, uh, several times of, of the cash flow. But, uh, um, without the catalyst, the stock, uh, uh, could, uh, remain undervalued and maybe go down. Um, and I just, uh, want to, uh, know, uh, your, uh, understanding of the, uh, or your suggestions regarding situations like this. Uh, what, what do you think about, uh, the importance of the catalyst?

    22. MPMohnish Pabrai50:15

        Uh, for the most part, you're right, I have ignored, uh, the importance of a catalyst. I think, I think catalysts are not required. Uh, I-- in most cases, value is its own catalyst. And I would also say that, uh, when you're buying businesses, uh, let's say below liquidation value, for example, um, uh, there are-- the-- in my, in my book, there's no such thing as a value trap. I think there are mistakes in investing, but not value traps. So in the end, um, everything is fairly valued. And, uh, so to the extent that you end up with a less than satisfactory re-return on an investment, it probably has less to do with whether the catalyst there or not, and more to do with just the nuances of intrinsic value of that business. Um, so, so I, I have actually found in many cases that, uh, in fact, uh, the catalyst actually flies in the face of uncertainty, uh, because if you have a catalyst, you don't have uncertainty. And I, just the nature of the type of investor I am, I prefer to buy low risk, high uncertainty, and let the catalyst work itself out. And, and it has, for the most part, I would say that, you know, from, uh, ninety-four, which is what, five years before I started my fund, till, uh, two thousand thirteen, uh, you know, before fees and all that, it's been a little over twenty-six percent a year. And that engine has not needed catalysts. But there's more than one way to skin the cat. And the Seth Klarman, uh, format of investing, uh, even though it's value investing, because value investing is a very big tent, is very different from the Buffett method of investing. One simple difference is, uh, Baupost has more than a hundred investment professionals, and, uh, at Berkshire, there's one. Uh, you might say one and a half with Charlie. Uh, but, but that's it, you know. So, um, so I think there's many different ways to skin, skin the cat. Uh, Seth's approach, uh, certainly has worked for a long time. Uh, but my personal preference and approach is the, to not bother with catalysts.

    23. SPSpeaker52:30

        Uh, hi. Uh, I have a two-part question. The first is, uh, we had a speaker last week, Michael Mauboussin. Um, he talked about untangling skill and luck in business and investing, and I thought it was very interesting. He gave the example of Bill Gates and how his mother knew someone at IBM, and that was part of the reason that he was introduced to that opportunity. Would you care to comment on that?

    24. MPMohnish Pabrai52:50

        Yeah, but I think that there's a lot of other people whose mothers know all kinds of people. [laughing]

    25. SPSpeaker52:56

        [laughing]

    26. MPMohnish Pabrai52:57

        And they-- Well, I would, I would say, yeah-- I mean, I would say with Bill-- So if you also look at the book Outliers, for example. You know, it talked about the, uh, ten thousand hours and all of that. So Bill Gates, a large part of the success of Bill Gates was when he was born, right? So if Bill Gates were born ten years before or ten years after, uh, it wouldn't have mattered what, who his mother knew. Uh, so, so I would say that, uh, that timing and such was definitely, uh, gave him tailwinds, very significant tailwinds. But I would also say that, uh, the Bill Gates and the Larrys and the Sergeys of the world, um, would tend to do well, even in the face of headwinds. They would not do as well at the-- as well as they have done, because to do as well as they've done, you'd have-- everything has to line up perfectly.

    27. SPSpeaker53:49

        Right. Right. Okay.

    28. MPMohnish Pabrai53:49

        Uh, but I would still say that, you know, you could throw Bill Gates in the fish tank with a whole bunch of other folks, and he'd come out ahead.

    29. SPSpeaker53:56

        Uh, the second part of my question is I recently saw a program about the Salton Sea, which was a very popular tourist area in, uh, Southern California in the fifties and sixties. And it was-- there was huge investment in that area and what seemed to be very li-- very little chance for loss. And then there was a flood in nineteen seventy-six, which decimated the area, and it never recovered. I'd like to get your comments on that, because, for example, if you bought motels in that area, it would have been a total loss.

    30. MPMohnish Pabrai54:23

        That's right. You know, the-- it's-- li-like I said, I think the thing with investing is, uh, there are no absolutes. So you're, you're trying to make what I would say are high probability bets. And certainly, if you are a Patel who's just left Uganda with Idi, Idi Amin breathing down your neck, and all you can do is buy one motel, uh, then, you know... A-and that's the nature of most business, uh, owners, is, uh, in certain times of their career, they will have extreme concentration risk.

Episode duration: 59:34