With Mohnish Pabrai, Founder and Managing Partner of Pabrai Investments Funds
Value Investor & Hedge Fund Manager Mohnish Pabrai
Today we bring you another segment in our “Great Investors” series, the first of two parts of an interview with hedge fund superstar Mohnish Pabrai. Pabrai has proven himself an astonishingly effective value investment strategist over the past couple of decades, beating S&P index returns by over 1000% in the past 16 plus years. Mohnish got started in the hedge fund business shortly after selling his business in 1999 and, almost from the beginning, the work and wisdom of Warren Buffett and his cohort Charlie Munger became a lodestone and inspiration for his investment strategy. United by a shared admiration for and curiosity about Warren Buffett and his Berkshire Hathaway hedge fund, Steve and Mohnish discuss Mohnish’s career as a fund manager, Buffett, large-cap tech stocks, and stock prices circa Q2 2017.
Berkshire Hathaway Shareholders Meeting 2017: Buffett, Tech Stocks
Both Steve and Mohnish went to the Berkshire Hathaway shareholders’ meeting in May 2017, and for Mohnish, it marked his 20th straight year of attending the event. Steve wonders what stood out to Mohnish this year if anything? Mohnish likens the experience to reading scripture which is familiar and consistent and strengthens core principles, but which always also offers a chance to learn something new. This year, he adds, the discussion of Google and Facebook and the top four largest companies by market cap—Google, Amazon, Apple, and Microsoft—stood out as especially interesting. Together, these companies make up 10% of the total value of public stock in the US. Despite the high prices, Mohnish argues that these companies are, in general, not overpriced thanks to their strong cash flows and dominant market positions. More than the competitive advantages in their industries that they might enjoy at the moment (which viewed as technologies or platforms alone are subject to disruption by competitors) they also have the more durable advantage of changing consumer habits, bending long-term behaviors through brand influence.
Buffett On Amazon & Google: The Ones That Got Away
Steve mentions his surprise at hearing Buffett talk about regretting his decision to pass on buying Amazon stock when it was cheap. Buffett says he didn’t recognize how special CEO Jeff Bezos would prove to be until it was too late to buy in at a price he found attractive. Steve found it fascinating that even one of the most successful investors of all time would have the kind of “big fish that got away” story of lament common to all private and professional investors. Mohnish counters that his read is that Buffett had even more regret over not buying Google in the early days. Buffett was actually propositioned for help by Google’s founders before their IPO and even got to see their very promising financial internals, but still passed on the early buy-in opportunity. Nearly from the beginning, Amazon had high price to earnings multiples—a tougher sell to a value investor like Buffett and, for that matter, Mohnish himself.
Stock Prices: Overvalued, “Fully-Priced,” Or Undervalued?
Speaking of stock prices circa June 2017, Steve comments that almost all of his investment advisement clients are worried that they’re too high to be based on reality (corporate earnings) and overdue for a correction or worse. Steve asks Mohnish if he sees the market as overpriced or not. He responds that stocks strike him as “possibly fully-priced.” Longer term interest rates hold the key, Mohnish says, if rates stay near their current low levels for the next 5-10 years, stocks look undervalued, and vice versa. The problem is that no one can predict where interest rates will be within that time frame.
The Difficulty Of Staying The Course, Strategically
Translating this into practical advice, Mohnish believes that even in the face of this uncertainty, it’s still a good strategy to own stocks from several major industries, probably through a low-cost index fund, and to hold onto them even during market routs when your emotions are screaming “sell.” Consistently investing a small portion of your income in the same stocks as a dollar-averaging tactic is the best approach over a decades-long time span. Steve notes that Charlie Munger has summed it up to the effect that the best way to get rich is to spend less than you earn, save the difference, invest it in index funds, and continue dollar-cost averaging for multiple decades. Mohnish marvels at the simplicity of the strategy and also at the failure of so many who’ve had great earnings over their lifetimes to end up rich. It’s a simple plan, but not easy to follow.
Steve asks how investors can overcome the seemingly hardwired instinct to exit markets when they’re falling, even though it’s widely known that buying the right stocks during market panics can be one of the best opportunities investors will ever get. Mohnish replies that putting your investment accounts on “auto-pilot” is the best long-term approach. Max your 401(k) employer matching funds and contributions to IRAs or other retirement accounts, and “ignore the noise” of volatile markets.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: This is another segment in our Great Investors Series, and I’m very happy to welcome back Mohnish Pabrai as my guest today. Mohnish began his investing career in 1999 after he sold his business, and then he discovered and studied the work of Warren Buffet and Charlie Munger. By his own admission, he says he’s been pilfering their ideas ever since. Mohnish and his good friend, Guy Spear, got to sit down with Buffet for an afternoon with Warren Buffet after winning the charity lunch in 2007. Finally, to add to Mohnish’s cred as a manager, his investment fund has crushed the return of the S&P 500 by over 1,100% in the past 16 to 17 years. Without further ado, welcome to the show, Mohnish.
Mohnish Pabrai: Well, Steve. It’s great to be back, and I love your show.
Steve Pomeranz: Oh, thank you so much. It was great to see you at the Berkshire Conference in May, although we had to get up pretty ridiculously early to get some decent seats. What did you think of the conference?
Mohnish Pabrai: Well, this year actually was my 20th year attending. I’ve been every year, so it was 20 years in a row. Every year, even though I think that the scripture in Bible if you will, is known well, every year I find myself learning something, and also then, the second bigger purpose of being there is just reinforcing core principles. This was great. This was another great year of having that.
Steve Pomeranz: Yeah. Was there anything that pops out as particularly special or different this year for you?
Mohnish Pabrai: Well, I very much enjoyed the discussion they had around Google and Amazon and also the discussion around the top four market cap stocks in the US, which are Facebook, Amazon, Google, and Microsoft, and those four make up something like 10% of the total market cap of all US stock.
Steve Pomeranz: Well, that has implications in itself, right?
Mohnish Pabrai: That’s right. And quite frankly from the way these companies are going and doing, it may not be that any of them are in [inaudible 00:02:36] territory.
Steve Pomeranz: Really? Because they’re growing so fast?
Mohnish Pabrai: Well, they have very dominant positions, and they have very robust cash flows, and in some cases, like, Apple, they are at a very modest multiple.
Steve Pomeranz: Yeah. And with all that cash and all of that influence, they can really push their way around and kind of own the industry, and that’s kind of a moat, this idea of having some kind of protection or business protection around you. Would you say that those companies—I mean, we’re talking about technology companies here—actually have a strong protective moat around them?
Mohnish Pabrai: Yeah. I mean, I think normally, tech businesses, you can say they’re kind of subject to disruptive innovation, but these are companies which are really part of, let’s say, habit changes in humans. When we buy things at Amazon or when we search for things on Google, and you know, just Apple TV and rebuying movies on Apple TV and such, those are more consumer-type businesses where the brands and the habit formations that they place on consumers can be far more resilient than the underlying technology. And so I think that gives these businesses some lags versus just a pure tech business.
Steve Pomeranz: What really fascinated me was his admission and his regret at not having invested in Amazon. I mean, as investors, I think every investor has some regrets, no matter how small an investor you are, the big one you miss, the big fish that got away, but to hear someone like Buffet, who’s accumulated and amassed so much wealth, to have such strong regrets about misunderstanding Jeff Bezos and the talent that he had, and, in a sense, missing Amazon as an investment, I thought, that really struck me very oddly.
Mohnish Pabrai: Yeah, and also I think he wasn’t so much in agony about Amazon as he was with Google because he said the Google guys actually both came to see him before the IPO. And they wanted help … 4.47 in They to plagiarize some of his owner’s manual and letters to partners and so on. Even before the IPO, Berkshire, through Geico, was a big customer for Google with ad words and such. Berkshire could see very clearly the power that [inaudible 00:05:30], and he was very aware of it and Johnny [Mungle 00:05:31] and so the economics of that were very apparent to them. They had a private audience with the founders. All the data that they wanted was available to them, and that’s one I think he regrets more.
I think Amazon is a difficult one for most of us because the multiple always looks so high.
Steve Pomeranz: Yeah, because they don’t hide their earnings, but they reinvest their earnings, so you don’t really see any return.
Okay. Let me switch gears here. I’m an investment advisor, and I would say that practically everybody who comes into my office is nervous about their stock investments. Although the market is hitting new highs, the general feeling is that somehow this isn’t real, that it’s all just smoke and mirrors and it’s going to come tumbling down any minute. What are your thoughts about where we are in the stock market? Is it justified? Are these higher prices justified?
Mohnish Pabrai: Well, I mean, I think when I look at the US market, I would say that I don’t see it as being overpriced, but it’s possibly fully priced. The only caveat there is if our low-interest rates persist for some extended period, then markets would actually currently be under-priced. It’s really hard to know where interest rates are five years from now or ten years from now, but if we could know that interest rates five years from now will be similar the way they are today or ten years from now, then stocks are a bargain.
I think the best advice is that it is not a bad thing to own fractions of great US businesses, and it’s not a bad thing to own them through some type of broad index fund with low costs and such. And the key thing is to not panic when markets go down. But you know, if you’re in your 30s, 40s, or 50s, and your dollar costs are averaging some small portion of your income, that’s a great way to go.
Steve Pomeranz: Well, I think Charlie Munger said that really the best way to become rich is to spend less than you earn, save the difference, put it in index funds, and just keep dollar costs averaging year after year, and after 20, 30, 40 years, it’s inevitable that you will be rich. Do you subscribe to that?
Mohnish Pabrai: Yeah, and how simple is that?
Steve Pomeranz: I know.
Mohnish Pabrai: And then the reality is, we end up with very few people who are actually rich, and lots of people who’ve, all their lifetime, have had tremendous earnings.
Steve Pomeranz: Yeah.
Mohnish Pabrai: Because these simple rules don’t get followed. Something that simple isn’t always easy.
Steve Pomeranz: Well, this is the thing. It’s one thing to say that the best bargains or the best buys are available when the markets are in their worst periods, but it’s a psychological characteristic to be able to buy when the whole world is telling you to sell. How does a good manager, how does a person, counteract those natural feelings?
Mohnish Pabrai: Well, I think the best way to do that is to not overthink it, put it on autopilot. Max your 401k with the employer match; if that’s not there, then max the amount that can go into your IRAs and such, and whatever you can save after tax, and then just have an automated system where your savings keep going into one, two, or three broad industries, and ignore the noise. Ignore the ups and downs, and you come out okay on the other end.
Steve Pomeranz: Yeah. My guest is Mohnish Pabrai, as I said, he’s a hedge fund manager who has a proven track record of really trouncing the SMP 500, and, basically, Mohnish, you came out of selling a business successfully, reinvesting that money and losing a lot of money in the next business, and then you came out and said, you know what, let me do it like Warren Buffet and Charlie Munger does it.