With Mohnish Pabrai, managing partner of Pabrai Investment Funds
Mohnish Pabrai, managing partner of Pabrai Investment Funds which he founded in 1999 is considered to be one of the world’s greatest investors and is this week’s addition to our “Great Investor” series.
Back in ‘94, Mohnish was the owner of a successful IT firm when a window opened into a new world as he began hearing and reading about Warren Buffett. He was particularly intrigued by the concept of compounding which Einstein called the “eighth wonder of the world,” leading Buffett to know early on that he would one day be rich. From there, Mohnish began his own compounding engine that eventually took him into a new direction.
Wise words from Warren Buffett
Warren Buffett has often been quoted as saying, “I’m a better investor because I’m a businessman, and I’m a better businessman because I’m an investor.” Mohnish took the core principle of these words and approached every buy as though he were buying either a fraction of or an entire business. Still within what he calls his learning period of the mid-90s, he
held on to the basic ideas of buying a dollar for well under a dollar and looking for businesses that were within the circle of competence.
Looking for the upside without a downside.
After following such great investors as Warren Buffett, Charlie Munger and others—whose style of investing went against the grain of most mutual fund investors at that time who were rapidly turning over scores of stocks with little or no regard to the intrinsic value of the businesses themselves—Mohnish set up The Pabrai Fund in 1999.
Contrary to the perception of the entrepreneur as risk-taker, Mohnish is quick to point out that successful entrepreneurs try to minimize risk and instead look for a business with the lowest risk possible but one with the highest potential rewards—the upside without a downside. He mentions Richard Branson as someone who has managed spectacularly well in this regard.
Lunch with Warren
In 2007, Mohnish won the coveted bid to have lunch with Warren Buffett. During that time, Warren spoke about integrity and, in explaining his internal yardstick, he asked the question “Would you prefer to be the greatest lover in the world and known as the worst or would you prefer to be the worst lover in the world and known as the greatest?” He then said, “If you answer that correctly, then you have the right internal yardstick.”
The takeaway for Mohnish from that lunch was that Warren highly values both integrity and truthfulness and looks to his inner scorecard in both investing and in life. Neither Charlie Munger nor Warren Buffett pays attention to what we would consider either acceptable investments or acceptable behavior.
Peter Kaufman’s 3 reasons for great success
Another of Mohnish’s influencers was Peter Kaufman who interviewed both Warren and his partner Charlie Munger for his book Poor Charlie’s Almanack, in which he listed the three reasons for their success:
- The willingness to be patient. Charlie Munger said they don’t make money when they buy stocks, and they don’t make money when they sell stocks, they make money by being patient.
- Extreme decisiveness. You must be willing to bet heavily if the opportunity strikes.
- Having no concern about being different from the crowd.
The keys to great investing
Becoming rich takes certain deliberate actions, according to Mohnish. Point by point, he advises:
-begin early, in your 20s, if possible
-always spend less than you earn
-take advantage of tax laws, IRAs, 401ks, etc
-invest in low-cost index funds
“Dollar-cost average that in throughout your life,” he says, “and even at very modest annual returns and very modest savings rates, you will end up solidly in the seven figures when you hit your late sixties or early seventies.”
Mohnish sums it all up
“Never, ever borrow against a 401-K, never ever liquidate it, always roll it into an IRA, always roll it into a low-cost index fund, and then don’t worry about the ups and downs of the market, just ride it out.”
All great advice from a great investor, but not necessarily for the faint of heart or your average hyper type-A personality. If you can’t find bliss, says Mohnish, while waiting out the process, you may not have the temperament for this type of investing. But if you do, employing the value system of Buffett and Munger can be a wonderful tool for living your life, both professionally and personally.
Steve Pomeranz: This is another segment in our “Great Investor” series, and I’m very happy to welcome Mohnish Pabrai as my guest today. Mohnish began his investing career in 1999 after he sold his business and discovered the work of Warren Buffett and Charlie Munger. I’ll let him tell it, but suffice to say, Mohnish’s investment fund has crushed the return of the S & P 500 since its beginning, and he’s considered one of the world’s greatest investors. Hi, Mohnish, welcome to my show, appreciate you being on.
Mohnish Pabrai: Steve, pleasure to be with you.
Steve Pomeranz: You know you started very untraditionally. You were not trained as an investment professional; you owned your own firm in IT. How did you actually begin your investment career?
Mohnish Pabrai: I started in ’94. I was 30 years old and, quite by accident, I actually just heard about Warren Buffett. I was lucky because the first couple of biographies on him had just come out, Lowenstein’s biography and also a couple of others. That, I found was very intriguing. That lead me to the Berkshire Hathaway shareholder letters and it just opened up a whole new world. What I had realized at the time—and I was an outsider looking into this industry—is that Warren was all about what Einstein called the “eighth wonder of the world,” he called “compounding the eighth wonder of the world.” Warren knew very early on that he was going to be very rich because of the unusual powers of compounding, especially when you have long runways and high rates of return.
I thought it was worth giving it a shot to start my own compounding engine, if you will, and see where it could go. I had a little bit of money saved up from the IT firm, and I decided I would try to apply Buffett’s approach to investing on my own portfolio and see what I could make of it. That did quite well, I think we were doing north of …this was the mid-90s … north of 60, 70 percent a year.
Steve Pomeranz: Was that mostly from tailwinds of the time because I would think when you first start out you’d be making some serious mistakes.
Mohnish Pabrai: Basically, the core premise that I took from Buffett at the time was, he has a saying: “I’m a better investor because I’m a businessman and I’m a better businessman because I’m an investor.” One of the things I’ve actually used for the entire 22 years that I’ve been doing investing is I’ve never thought of buying a stock as a piece of paper. I’ve always thought of it as buying a fraction of a business, and I’ve approached it as if I would buy the entire business.
If a company has, say, for example, a market cap of 500 million, the question I ask myself is, “If my family had $2 billion would we put one-fourth of the family assets into this business?” If the answer to that is “yes” then usually I’ll proceed with buying the stock, but I never look at, “Oh, it’s a $25 stock, I think it’s going to go to $40 …” or something like that. I don’t think of it like that. I think of it as ownership stakes in businesses. That type of thinking, of ownership stakes in businesses, what I found was unusual in Warren because most mutual fund investors at the time had such rapid turnover on scores of stocks. Typical mutual funds were about 50 or 100 stocks. They’re just dancing in and out of these positions, so they didn’t really think of it as, in my opinion, ownership of businesses.
In that period, I had a lot of learning—looking back—to do, but these core principles, which is buying a dollar for well under a dollar and looking for businesses that were within the circle of competence and thinking of them as businesses, stood me in good stead. Yes, because I had a tech background at that time in the mid-90s my portfolio was biased towards technology because that’s what I understood the best. We did really well on a number of them because I just understood the businesses better than most analysts would.
Steve Pomeranz: Yeah, but I think I saw an interview where you said you don’t invest in technology because you understand technology.
Mohnish Pabrai: That is correct. I’ll give you an example of how I leveraged my knowledge. One of the first investments I made when Pabrai Fund started in ’99, in fact, I think this was on the first day the fund started, July 1, ’99. There was a bank in Silicon Valley called Silicon Valley Bank. They still exist; I think they call it SVD or something. They had a very well-run bank and very prudent in their lending. The one unusual aspect of them was that any time they had any kind of loans or credit facilities that they granted to their account holders—and all their account holders were venture-backed companies, they were mostly venture-backed start-ups and such or more mature technology companies—what they would do any time they gave a line of credit, they would attach warrants to it. They would take warrants from the company in addition to the usual interest spread and all of that.
Steve Pomeranz: It was a proxy for you … I guess it was a proxy, as well?
Mohnish Pabrai: Basically, yeah. Basically, what happened is that Silicon Valley Bank had warrants on thousands of internet companies, and they had no disclosure on exactly what and how much they owned, just that they had this practice. The bank itself was trading at modestly above book value. I bought the bank, understanding that there was a moon-shot if these things took off, but I wasn’t paying for it, so it was an upside without a downside.
Steve Pomeranz: Yeah, I want to get to that upside, downside part of your investing strategy because one of the things that you said that really interested me was people think that as you are an entrepreneur and that you knew how to take risks and you were comfortable with risk, and I think you basically said the opposite, that an entrepreneur really is uncomfortable with risk and actually runs, in a way, runs a business that is as low-risk as possible but has the highest potential rewards. Take us through that a bit.
Mohnish Pabrai: Yeah. That’s right, it’s a misnomer that entrepreneurs take risks. Entrepreneurs try very hard to minimize risks. We have to separate start-ups into two different buckets: Venture-backed start-ups and the non-venture-backed start-ups. Venture-backed start-ups are less than one-tenth of one percent of all start-ups, maybe 100 to 1 percent, so we can ignore those. Non-venture-backed start-ups, which is what I am talking about, which is the bulk of it, what entrepreneurs do is they are arbitrage players, so they look for offering gaps. Let’s say there is a new town just coming up and there’s no barber shops. Someone’s going to look at that and say, “Well, you know, I can open a barber shop …” or “I have a barber shop in a neighboring town. I’ll set up a couple of chairs for a couple of days a week and see how it goes, and once I have the traffic I’ll expand it.”
They’ll kind of always look at, “How do I step my toe in the water and how do I get this going without taking a lot of risk? If you study the great entrepreneurs, you study Richard Branson or Lakshmi Mittal or the Patels with their motels and so on, which I talk to in one of my books, you’ll find repeatedly there is a common thread, which is they have embedded upside without much downside.
Steve Pomeranz: One of your initial influences, as I researched about you, was Poor Charlie’s Almanack by Peter Kaufman and you mentioned that Kaufman said to Buffett and to Charlie Munger, his partner, there were three reasons why he thought they were successful. I’d like to go through those if I can. The first one is the willingness to be extremely patient. Tell us about that.
Mohnish Pabrai: Yeah. That’s true. Charlie says that you don’t make money when you buy stocks, and we don’t make money when we sell stocks, we make money by being patient. He associates it to being like a man with a spear looking to spear a salmon and he stands by the river. It may be several hours until a juicy salmon goes by, but you’re patient. It’s extreme patience coupled with extreme decisiveness. You’re willing to wait a long time for a fat pitch, but when it comes along, you’re willing to bet heavily if it warrants that. Extreme patience with extreme decisiveness are two out of the three characteristics.
Steve Pomeranz: You mentioned that it’s not just being patient but you have to find bliss while you’re being patient. This has to be part of your mental/emotional structure and not everybody’s wired like that.
Mohnish Pabrai: That’s right. If you’re in anguish trying to clone Charlie’s model saying, “Oh, Charlie said I have to be patient, therefore I should be patient …” and you’re not in a Nirvana state, then it doesn’t work. You really have to be … In many ways I would say investing as a discipline fits for a certain type of personality and probably doesn’t fit for a different, let’s say, hyperactive type of personality. If a hyperactive trader tried to adopt Charlie’s model, number one, they’d probably be miserable and secondly, even if they tried to do it, they’d probably be unsuccessful at adopting that model.
Steve Pomeranz: In 2007, you won the bid to have lunch with Warren Buffett, which you shared with Guy Spier, who has been on my show a number of times. One discussion you had with Warren during that period of time, I think, points to this third attribute that Peter Kaufman from the Poor Charlie’s Almanack said. You talked a lot about integrity in your discussion with Warren Buffett at that lunch and Warren talked about the internal yardstick and he quoted this funny story. He said, “Would you prefer to be the greatest lover in the world and known as the worst or would you prefer to the worst lover in the world and known as the greatest?” He said, “If you answer that correctly, then you have the right internal yardstick.” The third point from Peter Kaufman in Poor Charlie’s Almanack was having no concerns about being different from the crowd or caring what the crowd thinks.
Mohnish Pabrai: That’s correct, and I think that is still true with Warren and Charlie today. They don’t pay much attention to what we would consider either acceptable investments or acceptable behavior. They measure themselves by what Warren would call an “inner scorecard”. I think that was one of the most important takeaways I got from that lunch. Warren has talked about the inner scorecard quite a bit. What that lunch did for me, it calibrated for me how important it was for him amongst a number of things that he values really highly. Obviously, integrity is really high on Warren’s list. Truthfulness is very high on Warren’s list.
The inner scorecard, which is you measure yourself based on your internal assessments of what happened and not based on what the world is telling you has happened or patting you on the back and such. What I have found … I have found the inner scorecard is a wonderful mental model for most individuals to have in their repertoire, and I think it’s a great way to live your life is measure yourself based on the internals because you have all the facts, whereas the world many times doesn’t have all the facts.
Steve Pomeranz: To trust yourself in what you know and make sure that you obviously do the work and you have it structured, but once you know, then trust your own instincts.
Mohnish Pabrai: That’s correct. I think Peter Kaufman, I think he hit it on the head where he said, “Extreme patience, extreme decisiveness, and the willingness to be different from the crowd.” In all three cases, to be of a personality type that none of that bothers you, they just come naturally to your personality.
Steve Pomeranz: To find out more about Mohnish and to hear this interview again, don’t forget always to join our conversation at stevepomeranz.com where you can hear this interview again, and, we will, of course, have a written summary and transcripts of this.
Mohnish, the skills needed for an investor to be successful, to understand a business, the temperament someone needs to succeed in investing, when you think of all of the abilities that it takes to be a successful investor, both technical and emotional, how should the average investor invest in the stock market?
Mohnish Pabrai: The best approach is to buy into a low-cost index fund and dollar-cost average. Taking a step back, it is, in my opinion, relatively easy to get rich, but it does require certain deliberate actions. The first action is: Right from the time you enter the workforce, let’s say in your early twenties, always consistently spend less than you earn. It’s very critical to spend less than you earn, especially in the very early years when you’re twenty-two, twenty-three, twenty-four years old. Take advantage of the tax laws, IRAs, 401-Ks, employer matches and all of that, max that out. All those options allow you to invest in low-cost index funds like the S & P 500 and so on. Dollar-cost average that in throughout your life and even at very modest annual returns and very modest savings rates, you will end up solidly in the seven figures when you hit your late sixties or early seventies. How simple is that?
Steve Pomeranz: It’s simple, but most people don’t do it. Actually, they stay away because the markets are bad and there’s a lot of talk in the media about this stock or that stock or how dangerous it is or maybe upcoming crash because something’s going to happen. There’s so much out there.
Mohnish Pabrai: Yeah, and it’s not only that investors hurt themselves with these types of decisions. I think one study found that the average size of a 401-K of a person in their 50s or 60s is less than six figures. What that means is that either people are not putting the money in that they should, which is really lost money because you’ve got employer matches. The second is that when they switch jobs they are taking distributions. That is one of the worst things you can do because you’re paying taxes and penalties. A simple thing is, never, ever borrow against a 401-K, never ever liquidate it, always roll it into an IRA, always roll it into a low-cost index fund, and then don’t worry about the ups and downs of the market, just ride it out.
Steve Pomeranz: Actually, when you’re accumulating money, the downs are your friend. You want the markets to be low, and you want them basically to be high when you’re ready to start taking some income from that.
Mohnish Pabrai: That’s correct. We shouldn’t really concern ourselves with the vagaries of the market; the markets are going to do their thing. The key is the length of the runway, start in your twenties, and the amount of money you put away. The annual rate of return does matter, but it becomes less relevant if you are very good about the first two factors.
Steve Pomeranz: It’s the consistency that really matters.
My guest, Mohnish Pabrai, one of the most successful investors today. I’m very honored that you would spend some time with us today, Mohnish.
Mohnish Pabrai: Oh, it was a pleasure, Steve.