[12/14/20] Being an investor is a continual learning
process. The only way one can keep up with the investment environment is
to change with the times, learn about different subjects and adapt to
the changing environment.
There are many examples of successful investors who've needed to make these changes to stay relevant. One is Mohnish Pabrai (Trades, Portfolio).
In a recent speech to the UCLA Student Investment Fund on Nov. 5,
Pabrai explained how his investment strategy has adapted over the past
few years.
A changing style
Pabrai started off as a deep value
investor. When he started his hedge fund around 20 years ago, he focused
on finding deeply discounted securities, buying them at a fraction of
their net worth and then holding the stocks until the discount between
intrinsic value and the market price had narrowed. As the value investor
explained in his recent speech:
"I was always looking -- for the last 20 years -- for discounted pies. I
didn't really care whether the pie grew or not. My take was that if I
bought a business for 40 cents or 50 cents on the dollar, and I've
always implicitly assumed that market efficiency would kick in in two or
three years. So if I'm correct that a business is worth a dollar and
I'm buying it for 50 cents, and I sell it for 90 cents and that
convergence takes place in two or three years, it's a very nice rate of
return in the 20s."
This "very nice" rate of return, he explained, removed the need to find high-quality compounder style businesses.
However, as he went on to explain, there
were two problems with this approach: the fact that "you've got to keep
finding the next one and the next one" and "taxes."
A much better approach, he observed, would
be to find high-quality businesses and sit on them for decades. But
this was not the way "Mohnish is wired," the value investor explained to
his audience.
"He is unable to pay up for great
businesses," Pabrai added. Other investors are more willing to pay up,
but "I know Mohnish and Mohnish is just not wired that way."
This is a remarkable statement because it
shows the need to understand our own qualities as investors. Lots of
different investment strategies achieve positive results, but there's no
point in following a process if you're not comfortable with it. This
realization won't occur overnight. It requires emotional intelligence
and experience to know what you are comfortable with, and more
importantly, what you're not comfortable with.
Rather than pursuing an investment style
he was not happy with, Pabrai took the best of both the quality and
value methods and merged them into something he was happy with:
"So I am limited to a universe where a compounder is maybe not recognized, or it has hit a temporary hiccup or something where the valuation is really cheap, but there is a genuinely long runway for growth ahead. Instead of just getting off that train when it looks fully priced, which is what I did many times in the past, the idea is to stay on the train and only get off the train when it gets so egregious."
Pabrai explained that he had made this mistake several times in the
past, which was part of the reason why his strategy changed. He had sold
good companies too early and moved on to other businesses that have not
been so successful. This was one of his main lessons of 2020, he told
his audience. But with "20 to 35 years" of life left in him, he added,
it was not too late to change course.
Pabrai is a classic value investor in the tradition of Warren Buffett, Charlie Munger, Seth Klarman and Joel Greenblat.
Like Buffett, Pabrai looks at a stock not as a piece of paper but as the ownership of a business. He has no interest in a company that looks ten percent undervalued. He is angling to make five times his money in a few years. If he doesn’t think the opportunity is blindingly obvious, he passes. This requires him to apply his X-Ray vision to the fundamentals, and weigh the downside risk (the margin of safety) vs. the upside potential (the moat) at a given price. His mantra: Heads I win, tails I don’t lose much.
Next, Pabrai practices patience. He takes Charlie Munger’s admonition to heart that money is made not in the buying or selling but in the waiting. As far as I am aware, he has not made a single new investment in 2013. He says that if he can find a couple of investment ideas a year, that’s plenty. His current preference is to keep a cash store of between 10%-20%. This seems like a tremendous drag for a fund posting numbers like his, but he is really biding his time for a distressed situation to come along when he can deploy this trove at the valuation he wants. During the next crisis, when everyone is jamming the exits, he will go all in.
Once you start purchasing stocks, Pabrai says the next step is to closely examine every trade that doesn’t work, and figure out what went wrong. Let me pause right here, because this is key to his whole method.
There is nothing more tempting that to sweep mistakes under the rug. Denial is one of our top defense mechanisms. If you are lucky, these trades come to haunt your sleep like Marley’s ghost. If you are unlucky, you repress them forever.
Due to his background in engineering, Pabrai does not gloss over mistakes. Investing is a field where you can have a high error rate (buying something you shouldn’t have, selling something you shouldn’t have, not buying something you should have, not selling something you should have) and still be successful. He takes as a given that mistakes are inevitable. The point is to learn from them so they are not repeated. A major portion of his annual meeting is devoted to publicly analyzing investments where he lost money for his partners. Lately these errors are becoming harder to find, so he has been reduced to talking about investments that didn’t fare as well as expected.
[Looking at dataroma, Pabrai has 8 stocks in his portfolio with over 99% in 4 stocks: ZINC, BAC, C, PKX. Hmm. Maybe I should buy more C?]
[11/28/14] "Forbes: So summing up in terms of what do you think do you bring to value investing that others perhaps don’t, that give you a unique edge?
Pabrai: I think the biggest edge would be attitude. So you know, Charlie Munger likes to say that you don’t make money when you buy stocks. And you don’t make money when you sell stocks. You make money by waiting. And so the biggest, the single biggest advantage a value investor has is not IQ; it’s patience and waiting. Waiting for the right pitch and waiting for many years for the right pitch.
FROM: Forbes Transcript: Mohnish Pabrai (Trades, Portfolio) 04/12/2010
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