Mohnish Pabrai: The Copycat Investor

If I had a million dollars…

It’s a common refrain. What would you do with a million dollars?

Well, we know what Mohnish Pabrai would do, because in 1994 Mohnish was sitting around with a cool million after selling some assets from his tech company and decided, after researching the wisdom of Warren Buffet, he would invest his money using the same techniques and principles of Buffet, essentially becoming a Buffet copycat.

That was the beginning of a storied and rewarding career of investing. Since opening his long-only equity fund, Pabrai has trounced the market, returning 517% vs 43% for the S&P 500.

He’s also written two books, The Dhando Investor: Risk Value Method to High Returns and Mosaic: Perspectives on Investing, both about his approach to investing. A good friend of Guy Spier, he and Spier paid over $500,000 to charity to have lunch with Warren Buffet in the mid-2000s.

Learning from history

Mohnish has an interesting story from early on in his investing journey. He invested in different Indian companies, including one called Blue Dart express, the FedEx of India.

Eventually, after the rise of the internet, he felt that holding a courier company was not wise. It was too much of a “brick n’ mortar” type of company and decided to sell. Mohnish called his broker to sell the stocks but they told him that the stocks he had were fake. When he had bought the stocks, in 1994 they were still paper certifications, rather than electronic. He still never thought they were fake and around 2015 he was looking again at the stocks are tried to sell them. This time the sale was successful as the brokerage company deemed them to be real. He ended up selling those stocks for 60x what he paid, 21 years later.

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That made him stop and think. Were there other times when he sold a stock too early that he should have kept?

He found out that it happened a lot. A lot of companies that he sold after earning a 3 or 4x return, ended up going on to return 10 or 20x. He found a pattern and then created a framework for finding these companies.

These are the key attributes Mohnish Pabrai looks for to identify and hold on to companies with the potential for huge returns.

  1. Wide and Deep Moat Companies That Can Be Run by Monkeys

An economic moat is when a business has a competitive advantage over other companies within the same industry. It makes it hard for other companies to take profits off a company with a large moat.

Mohnish calls these companies almost indestructible. Some of these companies have been run by so called “idiots” and still the companies don’t waver.

This attribute is a step away from his normal value investing approach because these companies rarely get to a bargain stock price. He uses Coca-Cola, Moody’s, and Visa as examples. Huge companies.

Case in point, Coca-Cola has been expanding for decades even with bad management. Looking at Moody’s, during the financial crisis of the late 2000’s, they were clearly shown to be terrible at the one thing they did. They couldn’t rate companies and stocks properly. That’s the one thing they did and they were bad at it. You’d think this would kill the company, but they had such large moats that they rebounded tremendously.

moodies

Moody’s is indestructible because of their large moat. A bad company with a huge moats will still do well.

  1. Wide and Deep Moat Companies Run by Competent Managers

These are businesses like Amazon, Walmart and Costco, all of whom have incredible economics of scale that they can leverage to incredible success. However, it takes a skillful manager to wield the company’s moat effectively.

These moats aren’t as large for these companies as they are for the companies described above but they are still very robust.

  1. Distressed Stocks

Pobrai looks at businesses going through bankruptcy, reorganization, public LBOs, busted LBOs and other special situations. Often these one finds these companies at very low prices because of these circumstances, Pabrai buys them and then holds them for a long time as they rebuild – gaining in value along the way.

For example, British Petroleum was embroiled in scandal after the Gulf of Mexico disaster. Their stock price before the oil spill: $60. 2 months later their share price had halved, before going on to recover over the next year.

  1. Buy the copycats, not the originals

According to Mohnish Pabrai, it’s better to find and buy stocks of companies that are clones of existing giants. So rather than buying Amazon, look for the clone that has a similar moat. Don’t buy Moody’s, buy CRISIL – India’s largest credit rating agency.

Pabrai goes even so far as to advocate the cloning of other successful hedge fund managers’ portfolios. That’s right – he copies their entire portfolio. He says that people think cloning in this way might be beneath them, but if it works, it works.

According to a 2008 study conducted by John Puthenpurackal at the University of Nevada, if you had simply mimicked Warren Buffet’s investment portfolio, by investing in the same companies Buffet invested in, you would have beat the S&P 500 by 10.75% over a 30 year period spanning 1976 to 2006. That’s just by digging through the public filings that Buffet is required to make and constructing your portfolio exactly as reported. In the same time frame, Buffet beat the S&P 500 by 11.13% so you’re not even giving up that much in gains by being a step late.

A lot of successful products are built on this same principle. For example, Microsoft Excel was cloned from Lotus. The only thing Pabrai suggests is that if you decide to clone – clone the best.

  1. Margin of Safety – always

Like the value investors that came before him, and the ones to follow, Mohnish Pabrai believes in building in a margin of safety into all of his investments.

The margin of safety is simply the amount by which a company is trading under its intrinsic value. Mohnish Pabrai estimates intrinsic value through a combination of a company’s cash flow, liquidation value as well as the value of intangibles (brand, goodwill, etc.).

It’s fairly straight forward to build out a company’s cash flow on Buycel. In fact, using Buycel we can build out the historical cash flows for a whole industry or sector.

Start by pulling in a list of companies from any industry you like by using Buycel’s list insert function.

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Once you’ve got a list of companies we can fetch data for the latest numbers on the amount of cash and cash equivalents. We can also use Buycel’s STOCK() function to fetch historical data on the same metric over the last 7 years.

 

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Cash flow and discounted cash flow analysis is part of any good value investor’s toolkit, helping them come up with intrinsic value estimates. If you have an idea of how much a company has made and will make in the future then you can get an idea of what it’s worth today.

Intrinsic value is subjective, but if you can buy a company below its intrinsic value then you are effectively controlling your downside risk. There’s very little downside risk in buying a company that is worth $100 million for $1 million. At the same time, there’s a lot of upside to be had on that deal.

Consider the case of Horsehead Holdings – a very low-cost producer of zinc. Their most recent 10-Q reports that they have plant and equipment worth $200 million. The company is going through turbulent times right now though and their share price has collapsed to $2 cents, valuing the entire company at just $1.15 million.

Simplistically, if Horsehead were to go bankrupt (which they are) and sell off all their assets they would have at least $200 million in the bank. So imagine if you were a single investor who bought the company for $1.15 million. If you immediately liquidate the company you make 200 times your investment.

Obviously, the situation is more complicated than that but it illustrates how important the concept of intrinsic value and margin of safety is when it comes to making money as a value investor.

  1. Don’t get confused by risk and uncertainty

Risk and uncertainty are different from one other. Uncertainty is when you don’t know what’s going to happen and have no way of attaching probabilities to outcomes. Risk is the opposite, you don’t know what is going to happen, but you have a way of figuring out what the probability of certain outcomes are.

In times when the market is nervous or scared, don’t be afraid to invest in low-risk, high-uncertainty businesses. When a recession is happening, it’s a time of high uncertainty but if you analyze a business and conclude that the probability of losing 10-50% of your capital is very low then you should go ahead and pull the trigger.

Mohnish Pobrai used the teachings of Warren Buffet to become a successful value investor who now has his own framework for finding the gems of the investing world.

Maybe you can pick up a thing or two from him.

 

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