Sunday, July 22, 2007

Profile of a superinvestor - Mohnish Pabrai

Occasionally a cult forms around an investor. In the case of Mohnish Pabrai (by now, he should be quite famous as an ardent follower of Warren Buffett), it’s a sub-cult of the mother of all investing cults.

While searching Amazon for classic investing books, two must-read books were discovered, both out-of-print, were selling for considerable sums. Seth Klarman’s Margin of Safety was going for $1,700 and Mohnish Pabrai’s Mosaic sold for $340. You might think the price on Klarman’s book the more remarkable. On calculation, by buying and selling, Margin of Safety, first published in 1991, would have turned in 29% a year. On the other hand, Mosaic, in just three years since its publication, has put in 144% a year.

The price on Mohnish’s book is only one of a number of indications that a cult is developing around him. He’s all over the internet.

No doubt one of the reasons is his new book, “The Dhandho Invesor.” A value blog likes it as to say, “If you want a book to help you understand value investing, this book can help you accomplish your goal.”

Before becoming a value investor like Mr. Pabrai, you’ve got to admire a pundit who, unperturbed by the incredulity of his Bloomberg hosts, won’t be drawn into breathless comment on the recent 100-200 point moves in the stock market.

Investors, says Mr. Pabrai, should think like a businessman, not a Bloomberg presenter.

“I talk in the book about this concept of low risk, high uncertainty. So there’s a perception that entrepreneurs are risk takers. Well, in reality entrepreneurs avoid risk. They try to minimize risk…They do absolutely everything to minimize the downside. But they are also humans that are very comfortable with uncertainty. So they can believe a wide range of outcomes and be very comfortable.”

Minimizing the downside means buying stocks that are hated and unloved, often ignored by Wall Street, that have already reached a “floor.” Sounds familiar? It should. Mr. Pabrai describes himself as a follower of Mr. Warren Buffett, often referred as the world’s greatest investor:

“I’m just a humble disciple, or like you say I’m a shameless cloner.”

One of Mr. Buffett’s many insights run against conventional investment thinking, and by the sound of it, it’s the origin of Mr. Pabrai’s contrarianism. Conventionally, risk means volatility (measured by a share’s beta), so a falling price makes a share more risky. But, as Mr. Buffett explained, in a speech at Colombia Business School in 1984, subsequently became one of the best investment speeches that gives a profile into the genes of a superinvestor, in a value portfolio the bigger the expectation of reward, the lower the risk.

For example, in 1973, the Washington Post Company had a market capitalization of $80m although its assets were worth at least $400m, Mr Buffett said:

“Now, if the stock had declined even further to a price that made the valuation $40m instead of $80m, its beta would have been greater. And to people who think beta measures risk, the cheaper the price would have made it look riskier. This is truly Alice in Wonderland, I have never been able to figure out why it’s riskier to buy $400m worth of properties for $40m than $80m.”

Mr. Buffett was paying homage to a concept developed by Benjamin Graham, the father of the cult of value investing. That concept was the “Margin of Safety,” purloined by Seth Klarman for the title of his book. Mr. Buffett explains it this way:

“You don’t try and buy businesses worth $83m for $80m. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And the same principle works in investing.”

In other words, the lower the price relative to the company’s valuation, the higher the margin of safety. A low price reduces risk. If you watched the interview with Mr. Pabrai, you’ll have noticed he really has shamelessly cloned that model, passed down, as it were, from Mr. Graham, to Buffett, to him.

So why listen to Mr. Pabrai, when you have the works of Benjamin Graham and Warren Buffett? Well, Mr. Graham died in 1976, so the focus must, to an extent, switch to his disciples.


fishman said...

Hi Bershire, it's great to read your post again!

very thoughtful post. you must have spent a lot of time doing research!

In many ways I've "evolved" as I read more blogs and more books on value investing. For example I no longer pay much attention to the articles in "The Edge" that tries to forecast too much into the future.

But now as I try to start on value investing in stocks itself, I'm stumped as to how to go about doing it!

pershaps if you don't mind, you can share with us your valuation process? I know for me that'll be most beneficial!

ThinkNotLeft said...

Hi Bershire

'So why listen to Mr. Pabrai, when you have the works of Benjamin Graham and Warren Buffett? Well, Mr. Graham died in 1976, so the focus must, to an extent, switch to his disciples.'

I feel that your last paragraph is more false than true. Every value investor is different in their own light, even though they may practice the idea of buying below intrinsic value.

Monish Prabai, through studying Beffett and Graham and his personal experience, comes up with high uncertainty, low risk and good profit approach.

Marty Whitman, through his academic background and study of graham, comes up with his unique buying companies with strong balance sheet.

Klarman, again, prefer to seek more certain gains through bankruptcy investing and debt recovery investing etc.

There are many aproaches to value investing. Graham and Buffett stuff is not the everything one can find in the field of value investing.

Berkshire said...

Hi Fishmen,

Thank for dropping by. I wouldn't mind sharing my valuation process but it is very difficult to write every thing on this reply. In fact, my method of valuation can be taken as a whole from each and every article that I had wrote so far on this blog.

What is important is one must have a strong conviction and belief on the system that he or she is tagging along without being distracted by some other systems along the way that try to call out to you and provide you a chance of succeeding as well but in a different manner that you couldn't understand as well you have understood the current one you are following.

Personally, I think everyone knows how to differentiate being value and price and the basic mathematics of calculating. Investing besides identifying a good business with a sustainable model and calculating its value, there lies another yet more important metrics, the participant's emotional and mental stability to ignore the crowd and trust your own judgement.

Everyone knows Coca Cola or Pepsi is a fabulous product with an almost indestructable product. You can also easily put a decent value to it, if it goes to certain price that meets your value, you buy, if not you don't. Ok, but in investing, for example, if Coke is priced at 40 times its earnings and trading at $100 today. And you have calculated it to be worth only 20 times earnings and would only buy at $50. Would you then buy if it really drops to $50 within 2 months? The market may view Coke to be extremely volatile and risk because its beta risk has increased since it plunged from $100 to $50.

If you can overcome your emotional state by ignoring your net-worth that will almost certainly varies from day to day, and based your judgement on what you calculated as good value, then you are in the right game.

One advice which I find very useful is "Never let yourself go to the game. Let the game comes to you."

As I am writing, I still have lots to learn which is fun.

And in investing, analysing stocks and buying stock are most fun. When conditions are right, when companies with the good economics and management which sells below intrinsic business value will provide grand-slam home runs.

Fear and greed are as unpredictable as it is. As it is today and last month, who is to say that this month investors will be so fearful on the potential credit crunch that they worry about? In investing, you buy a stock regardless of the macro-economics of the world, if you can identify a great business at a great price. No great investor will try to time the arrival and departure of either the fear or the greed. Simply, when people are fearful, you should be greedy or v.v.