Mohnish Pabrai on How Biases Lead to Investment Mistakes

Mohnish Pabrai participated in the “Talks at Google” series in 2017, sharing his insights into deeply entrenched biases and our flawed evolutionary brain, which make us prone to make plenty of mistakes when picking stocks.

Specifically, the more time we spend analyzing a given business, the more likely we are to like it and invest in it. But if we don’t spend time studying a business, how are we expected to understand its prospects and likely future? This strong commitment bias is an important reason why most investment managers have trouble beating the index. Mohnish laid out the origins of this bias problem and shared a few “hacks” to get around it.

We are pleased to provide the following transcript as a courtesy. The transcript has been edited for space and clarity. It may contain errors.

Mohnish Pabrai: One of my motivations for sharing is to try to learn myself; some of my thoughts are not fully formed. I hope these ideas will get pounded into my brain a little better because I get to talk about them, and some insights might come from you.

In Los Angeles, there is a large active asset management shop that some of you might have heard of. It’s called Capital Group. They’ve been around for about 85 years, and they manage about $1.4 trillion. Capital Group has a number of different funds, like Fidelity. But unlike Fidelity, which has star managers like William Danoff and Peter Lynch, Capital Group runs things differently. They assign teams of managers to manage a specific fund, and each manager manages a few hundred million to maybe a billion. Then they collect all the different managers’ stock picks, and that’s what comprises the whole fund.

A few years back, I was at a dinner at Charlie Munger’s house. It’s a small group. He said the Capital Group set up what they called a best-ideas fund a few years ago. They asked each of the portfolio managers to give one stock pick, their highest conviction idea. Then they created a best-ideas fund based on these picks from each of the managers. Charlie said this best-ideas fund did not do well. It underperformed the benchmark. He asked our small group to explain this outcome. Before we could get further into the discussion, dinner was served, everyone moved, the conversation shifted, and this thread got left unanswered. This was five or six years ago. Charlie and I would talk occasionally and either I’d forget or there’d be a lot of people around. I thought I had the answer for why this happened to the best-ideas fund, but I didn’t know because God hadn’t told me why it happened.

Earlier this year when I was with Charlie, I planned to make sure this is the first thing I would bring up to bring closure to the issue. I said, “Charlie, you might remember five or six years ago,” and I brought up the Capital Group and he beamed. He said, “Oh, yeah. I remember that well.” I said, “What was the reason the best ideas fund didn’t do well?” He said, the best-ideas fund didn’t underperform just once. They tried it several times. Each time it failed. He said, “Before I answer the question why it failed, I want to tell you a story from my days at Harvard Law School.” He said sometimes when they had classes at Harvard Law, the professor would bring up a case where the facts didn’t lead to an obvious conclusion about which side was in the right. It could go either way. Then they divided the class in two halves randomly. One half would argue for the defendant, and the other half would argue against the defendant. Then the two sides went off and studied the facts and then made their arguments. After all of that was done, they surveyed the entire class. Overwhelmingly, the students who had argued for the motion believed strongly they were right, and the people who had argued against the motion also believed strongly they were right. Before they had studied the facts, they didn’t lean one way or the other.

Then Charlie quoted this English actor, Sir Cedric Hardwicke. Sir Cedric Hardwicke was a bit of a smartass, but he said, “You’re already fooled.” He said, “I’ve been a great actor for so long that I can no longer remember or know what I think about any subject.” Charlie said that even the temples and churches make you repeat stuff because as you shout it out, you pound it in. The best-ideas fund, Charlie said, were simply the picks the managers had spent the most time on. When they spent the most time on these ideas, they were the most excited about them. When they put all of these ideas together, things didn’t go so well.

In Poor Charlie’s Almanack, he talked about how the human mind is a lot like the human egg. Once the first idea gets in, just like the human egg, it locks up and seals off any additional ideas from coming in. You have what he calls commitment and consistency bias where we get locked into what’s taken hold in our brains. We see this even in political discourse. If you talk to folks who love Donald Trump, they can’t see anything wrong with him. If you talk to folks who are on the other side, they can’t see anything right with him. And then of course, the reality is probably some shade of gray in the middle there. Warren Buffett also has a great quote. He says what human beings are best at doing is interpreting new information so that their prior conclusions remain intact.

There’s a second reason the Capital Group’s best-ideas fund didn’t do well. The portfolio managers specialize. One specializes in utilities, another in the coal industry, another in artificial intelligence, and so on. Therefore, if you go to the guy who’s focused on the coal industry, he’ll probably give you the highest conviction coal idea he has. It’s like a horse that can count from 1 to 10 is a smart horse. It’s not a smart mathematician. What you want in the portfolio is not the best coal company. What you want is the best stocks. This siloed approach to people having specializations can lead to underperformance.

Getting back to the human mind and the human egg, I thought about how we might counter these biases. It’s important because on one hand, we cannot make investments until we spend time studying companies. But if you spend time studying companies, you get biased. I thought about how I try to build a framework which can get around some of these issues. I came up with a few hacks. I thought there might be two or three things, at least, I can think about that can be useful. The first hack was being aware of these facts; this is a huge advantage. Being aware of our biases and how our minds can play games and tricks on us can help us be more rational. Charlie Munger says he hasn’t been successful because he’s smart. He has been successful because he’s rational. Another useful thing is to be fluent in the other side of the argument. If you’re going to go long on a stock, it’s probably a good exercise to spend time developing a thesis on why to go short. That forces your brain to think about things it normally doesn’t want to think about. This first hack is to be aware and let rationality prevail.

I want to go back to Warren Buffett’s childhood, when he was a teenager, before I get to the second hack. Warren Buffett used to go to a racetrack in Omaha called Ak-Sar-Ben. It’s Nebraska spelled backwards. After all the races had been run, he’d collect all the discarded tickets people had left throughout the racetrack. Then he’d go through each ticket carefully to see if they were discarded tickets that were winning tickets. Because people are having fun and maybe drinking, they might have a winning ticket and not realize it. He would always find a few of these discarded winning tickets. Because he was underaged, he used his Aunt Alice to go to the window and collect on these tickets.

In 1993, there was an author who went by the name Adam Smith. He wrote a few books including Money Masters and Supermoney. He was interviewing Warren Buffett and asked, “If a younger Warren Buffett were coming into the investment field today, what would you tell him to do?” Buffett said, “Well, I would ask him to do exactly what I did, which is if you’re working with small sums, learn about every publicly traded company in the U.S.” And then Adam Smith said, “But there are 27,000 companies.” Warren Buffett’s answer was to start with the As. It sounded like a facetious reply, but it wasn’t. At the 2001 Berkshire shareholders meeting, Buffett said when he started in 1951, he went through every page of the Moody’s Manual twice. A set of Moody’s Manuals was 20,000 pages. In fact, I bought one recently on eBay. It’s got about three or four companies per page, and it goes for about 1,500 pages. There’s a lot of data there. He went through that one year twice.

In 2006, he talked to students at Columbia University about going through the Moody’s Manual in 1951. I’ll just read that. It was an absolute question of turning the pages. On page 1,433, he found Western Insurance. In 1949 they earned $22 per share, $29 per share in 1950. In 1951 the range on the stock price was between $3 and $13, just less than half of previous years’ earnings. He went to a broker and looked at the manual. He found nothing wrong with the company. Then 10 pages later, he found National American Fire Insurance. Then he says this book got sensational towards the end. In 1950, you’re down $29, the share price was $27, book value was $135.

In 2005, just a year before he met the students, he told them someone had sent him a Korean stock market guide. I’ve seen it. It was put out by Citibank. He spent about five or six hours on a Saturday going through this list of Korean companies with some of the basic information. He picked out about 20 companies from that list and he put about $100 million of his personal portfolio into those 20 companies. For example, there was Daehan Flour, which sold about 1/4 of the flour in South Korea. It had earnings of 13,000 won three years ago, 18,000 won two years ago, and 23,000 won a year ago. It had over 100,000 won per share in equities, and the whole thing was going for 38,000 won. He did well with his Korean escapades without knowing a whole lot about the businesses. He just went through them purely on a quantitative basis.

In 2011, my friend Guy Spier and I found ourselves in Warren Buffett’s office. The Japan Company Handbook was on Warren’s desk. I was familiar with that handbook because I had a subscription to it. I was surprised to see that on Warren’s desk. I asked him about it because in 2011, Berkshire Hathaway can’t buy Mickey Mouse companies. I went through the Japan Company Handbook looking at Japanese net-nets, companies creating well below their liquidation values. I asked Warren why he was fooling around with the Japan Company Handbook. He puts on a poker face and didn’t say anything. Then I picked up the book and Guy and I dog-eared some of the pages of companies we had found that were interesting. Without asking him, we mutilated his copy. Most of these companies were toward the back of the book. He said, “Yeah, it’s always the case. It’s the back end where all the good stuff shows up.” And then of course, he didn’t tell us anything more about what he did with that book. But that was, during daytime hours at Berkshire Hathaway, what he was doing.

All of these exercises are the same: The teenager at Ak-Sar-Ben, the young adult going through the Moody’s manual, the much older adult going through the Korean stock book, and then the Japan Company Handbook. They are all exercises in which you spend a little time on either a given ticket or a given company, and you’re going rapidly through. If you’re cycling through 40,000 pages with 50,000 or 80,000 companies in a year, you’re clearly not spending much time on any single company. He was looking for specific patterns. When he saw those patterns, he acted. To see a pattern, it had to hit him over the head with a two-by-four. Either it had to be a winning ticket at Ak-Sar-Ben, or it had to be a stock where it would just stop you in your tracks: $100,000 in book value, trading for $40,000, making $25,000 a year, that kind of thing.

That brings me to the second hack, which is, to paraphrase Nancy Reagan, just say no quickly. We have this built-in bias where once we spend time, we get pregnant with the idea. Don’t spend a lot of time. You are rushing through a lot of stuff and only spending time on stuff that is looking like an absolute no-brainer. One of the things about the investing business which is better than baseball is there are no false strikes. We can let hundreds and thousands of ideas go by and it doesn’t matter. It doesn’t matter if you miss something that goes up 10x or 100x or 1,000x. What matters is what we invest in. It’s a forgiving business from the perspective we don’t need to know everything about everything. We don’t need to act on everything. We can miss lots of stuff, and it can still work out well.

The advantage of just say no fast is that it frees up a lot of time. Often when I look at a business I’m done in seconds. Maybe it takes 10, 15, 20 seconds. For example, on a typical day in the office, people send me investment ideas, which is great. I love to receive investment ideas. It’s [email protected] Feel free. When I get in and look at these ideas, I just look for two numbers, the stock price of the idea being pitched and what the person says it’s worth. Unfortunately, most of the things I receive will be like the stock is at $12 and here’s all the reasons it’s worth $16. When I see something like that, I’m done in about 10 seconds. I don’t even bother to figure out whether it could be worth more and the person missed it. I assume there’s some intelligent person who thought about it and I’ll give him full benefit of the doubt that they got it right. It’s the same thing with most companies. When I look at them, if it doesn’t hit me with some intensity in the first few seconds or first few minutes, I move on. In 2012, I spent a lot of time – probably two months – doing nothing but studying Fiat Chrysler and General Motors. It frees up a lot of time to study the businesses, but you’ve scanned a lot of stuff on the horizon before letting things in.

That’s the second hack: Say no fast. If you are a voracious reader and you buy into what Charlie Munger says is the “latticework of mental models”, then things will often come together in a rapid timeframe. Warren talks about how he got a cold call from a banker who suggested to him that Dairy Queen, which was privately held, was available for sale. Warren said, “We have our acquisition criteria listed in our annual report. Does it meet all the conditions?” The guy said yes, so Warren said, “Send me the numbers.” In less than half an hour, Berkshire had made an offer and they had a deal. There was no way Warren Buffett could have looked at Dairy Queen before because it’s not a public stock, but he knew enough of the business to understand there’s a certain way you look at franchise businesses. You can figure out what they’re worth and what you want to pay for them. He went through the math quickly. He had an investment in McDonald’s, which he probably studied at some length, and that probably got him where he needed to be.

The third hack, which is related to the second hack, is this notion Eli Broad talks about in The Art of Being Unreasonable. It’s a great book. Broad is a successful entrepreneur. In the quest for investments, be unreasonable. Don’t settle for a company trading at $13 when it should be $18, and that sort of thing. I always tell people, please try to send me things which are a P/E of one because a P/E of one is great. Maybe a P/E of two is great, too. I can deal with that. Single-digit math is easier to deal with. There are over 100,000 publicly traded stocks on the planet. There are always things going on with different companies getting into distress or high growth or various other things. Because these are all auction-driven markets, they have wide swings. You can throw a dart at a New York Stock Exchange company, look at the 52-week range on the company, and it’ll be something like $75 to $150. If you pick a random home in Palo Alto, you won’t see that kind of fluctuation in the home price. Auction-driven markets have this nuance where they either get euphoric or pessimistic, and they might do both in the same year. That’s what leads to distortions and mispricing, and that’s what we can take advantage of.

The following are excerpts of the Q&A session:

Saurabh Madaan: I’ll pick up from where you stopped. The stock is at $12. Your target price is $18. Let’s bring the element of time into the picture, as well. Something is $18 today and going to be $26 tomorrow. How do you look at time horizons in your analyses?

Pabrai: $12 to $18 is not interesting because that’s 50%. I know 50% sounds like a lot, but one of the things is that in value investing, there’s a free lunch. The free lunch is that the greater the margin of safety, the higher your returns. If a company is worth $18 and if I can buy it for $4, I’ve got huge downside protection in terms of what might happen. In business and in capitalism, it’s brutal, dog eat dog. You’re at the cutting edge of all these guys who want to encroach on your territory. Businesses are not steady state entities. They fight for their survival. When we are trying to project the future of a business, we should demand huge margins of safety. That’s another reason why the $12 to $18 is not that interesting, because it’s not so much the timeframe. If there’s a catalyst in place, let’s say some company will be acquired for $18 in two months and it’s sitting at $12. If you think it will close, then sure. You go for it because everything is encapsulated.

Madaan: My question is more around quality versus net asset value bargains. You could be looking at a net asset value bargain worth $18 and selling at $12. In contrast, you could be looking at a quality company you think is worth maybe $18 today but five years from now it could compound to a much higher value, whereas a net asset value bargain or a commodity company five years from now might not necessarily have the same appeal.

Pabrai: It is always better to buy compounders. It’s always better to buy growth. If you’re buying an asset because it’s cheap, your upside is limited. Buying cheap assets, in my opinion, it’s not the name of the game. You want to get to high growth where the intrinsic value increases over time, but you want to be extremely unreasonable. High growth at a P/E of one, can we do that? I’m saying any fool can see Amazon will grow a lot. Google and Facebook will grow a lot, too. It’s a lot harder to figure out what the returns would be when you’re investing today. They’re probably still good returns. These are durable moats, so they will probably be around for a long time and they are probably great investments even today. But we have 100,000 stocks to choose from. Why not do some digging without spending too much time on one? And why not try to find the diamond in the rough and then take it from there?

For example, in 2002 Charlie Munger said he had read Barron’s for 50 years, from the 1950s until 2002. Probably every issue of Barron’s has at least 5 or 10 ideas. He said for 50 years, he read an issue every week. That’s 2,500 issues and 25,000 stock tips, and he didn’t act on any of them. He acted on one Barron’s stock tip in 2002, which was Tenneco. By 2004 or 2005, he had made 8x on that investment. Tenneco was under distress. The stock went to $1.60. Eventually, it went back up to $55. He was out at $15 to $20 a share. He invested $10 million and it grew to about $80 million in two or three years. Then he invested the proceeds elsewhere, and that money is now $500 million or so. This is happening in our time. This is not some 1950s story. From 2003 to 2017, without riding Google or Amazon, he got to 50x. That’s 30% a year or something. You must ask, what caused that? The answer is extreme patience coupled with extreme decisiveness and being unreasonable about what valuations he wanted. That’s the mantra.

Madaan: One of the nice things to see at this year’s Berkshire meeting in Omaha was Mr. Buffett and Mr. Munger being candid about how they’ve been changing their own ideas about investing. They’ve also been candid about admitting mistakes. In that same spirit, we’d be interested in learning your insights from things that you’ve learned in over two decades of investing now, specifically from mistakes.

Pabrai: First, just in terms of what happened in Berkshire in Omaha was an eye-opener for me. Warren pointed out these four largest market cap businesses in the U.S., Facebook, Amazon, Google, and Apple. Microsoft might be in there, too. The top four or five of them are about $2.5 trillion or so in value, which is almost 10% of the value of all public equities in the U.S. He didn’t say it was anywhere near obvious these were in bubble territory in the sense that these are businesses that can be run without capital. They run on negative capital. They have two characteristics: They run on negative capital, and they are high growth. When you have a business with negative capital needs in high-growth markets, those are the holy grail of investing. He regretted the fact that in the case of Google, the founders had visited Omaha. They wanted to get Warren’s permission on use of his letter and principles. Many of the Google principles are Berkshire Hathaway principles, too, which is fantastic. He said they were a Google customer. They were spending on AdWords. It was obvious to them it was a great business, but he blew it.

That was a great insight. We value investors must be cognizant of a definitive change taking place in the way the world works. It’s concentrating into a few companies doing an excellent job. Not being able to have exposure to those businesses is a negative. On the other hand, there are a hundred ways to nirvana. You can get there with other companies, as well.

As for the lessons over the last couple of decades, one of the biggest is to not focus on cheap assets. Historically, I always wanted to buy things that were cheap. I discounted the value of quality. My take at this point is I want both. I want to get more unreasonable. I want cheap and good; or better yet, cheap and great. The idea is you sit and do nothing for long periods and you study areas that might be possible and they show up from time to time because you have such a large base of auction-driven companies. Another lesson happened more recently, which is to focus on stocks in India, for example.

Madaan: Tell us a little more about investing outside the U.S. Your U.S. portfolio is easily seen through a 13F, and you are the master of cloning. You popularized this idea, so people are using it for you.

Pabrai: I was surprised that more than 70% of the assets in Pabrai Funds sit in companies domiciled outside the United States. That’s the highest number it’s ever been. I’ve usually been heavily invested in the U.S. None of this is by design. I’m a bottom-up stock picker. I go wherever I can find opportunities, so it just happens that’s where it led. India is around 25% or 30% of that pie. I find it interesting that India has about 5,000 public companies and probably 4,000 of them are not followed. They’re small, family-controlled businesses now. They have a lot of governance issues. They have a lot of honesty issues. They have lots of different issues.

One of my principles used to be that I never met managements or visited the businesses. It was inefficient. One of the negatives about meeting management is that you talk to people who are exceptional at sales. Ben Graham said it would lead to a negative distortion. But one of the changes I made was my decision I couldn’t do India without meeting managements. India is a lot more like private equity with some of the smaller businesses. I started making trips where I meet various management teams in India, and those have been exhilarating. I’ve met some companies that are outright frauds. It’s fun to sit in a room with the frauds and to see what they look like. There were no horns growing. Then there are others who are exceptional entrepreneurs with great runways and great governance. This is early in that process, and I visited or met with maybe a couple dozen companies.

Madaan: For young students and young individual investors who will listen to this conversation on YouTube, will you share an example of an investment outside the U.S.? Will you walk them through how you found something like this so they get the same inspiration around these ideas?

Pabrai: On any given day, one, two, or three ideas show up. Most don’t take more than a few seconds. But a little over two years ago, some person I didn’t know sent me a 10- or 12-page writeup of a company I had never heard of. It was a company in India called Rain Industries. I did a quick check on the two numbers I care about, which is the recent stock price and the target. In the writeup there seemed to be a zero added to the recent stock price, to the target. That caught my attention. That’s my guy, and so I said let’s read what’s going on here and see what drugs this guy is on. I sat down to read the report and it was immaculate. The report is on the web if you do a search for Rain Industries and the guy who sent it to me. His name is Rajiv Pasricha. I haven’t met him yet; he lives in Delhi.

Everything he said about the business and the way he explained it was awesome. The only thing left for me to do was ratify the facts. He stated the business the company’s in, where it’s going, its market cap. He stated what it’s worth and why. I spent probably not more than a few hours testing each number to verify accuracy and everything else in the report. It wasn’t a large business; the market cap at that time was about $200 million. In India, we can’t buy more than 10% of the business, so that’s what we own. We own about 9.5% of the company. So far, it’s tripled in price. But it didn’t do anything for 20 months, then in six months, it came alive. It will probably keep going for a while. That’s an example of where unreasonableness paid off.

Madaan: Ben Graham had a rule, maybe more of a heuristic than a rule. If something doesn’t do too much for three years or four years, he would say let’s discard this and rotate. With a company like GM, which hasn’t done much since the IPO, how do you think of this heuristic?

Pabrai: It’s a good heuristic. It’s especially good when you think about all the biases that can creep into our brains. We have a large position in GM. We have some gain. We don’t have a huge gain. Certainly, the annualized return since we’ve owned it is low. The stock is cheap. We’ll see how the future unfolds. We might not get much return even though the cash flows and everything are likely to come in simply because the market is always concerned about what happens in the future. My thinking of the GM position at this point is to think of it as cash and think of it as available for something more unreasonable.

Madaan: I have two more questions for you. One is about Dakshana. This year one of your students was in the top 50 All India Rank in the Joint Entrance Exam. Will you tell the audience and folks on YouTube a little about how Dakshana started and where it is now on its journey? It has been a big compounding engine for you.

Pabrai: Yes, I’m a shameless cloner. It’s good to be a shameless cloner. I’m probably influenced by Buffett in my belief the best course of action in terms of wealth is to recycle back to society. If you try to give it to your gene pool, in general, it will do more harm than good. I knew a while back that we wanted to recycle back to society, and I was looking for a cause that resonated and delivered a high social return on investment. Then in 2006 I ran into a guy in Bihar who ran this program called Super 30. I was impressed. I met him in 2007. I wanted to fund him and scale that program. He was picking up kids who came from impoverished backgrounds in Bihar. He was spending about eight months with them, 30 of them at a time. Almost 100% of them would go into the Indian Institutes of Technology (IIT). He took a family where the incomes are $50 to $100 a month and their kids got into IIT. Then they got hooked into the global economy where they make tens of thousands a year in India. They make even more if they venture into places like California; that was a no-brainer. Plus, this permanently unshackled the family and the extended family. When he said he didn’t want to scale, then I said, okay, why don’t we clone his model? I asked him if he had any concern with me cloning. He said, “No, that’s great. Feel free. I’ll try to help you, as well.”

Dakshana was set up as a vehicle to try to clone Super 30. We identify kids who are poor but talented and gifted. If you get a kid into IIT, there’s a high government subsidy, probably an 80% or 90% government subsidy. The education is almost free, and you only pay a few thousand dollars per year. Students can get loans for that. The easiest way to reach or to lift a family from poverty is if there’s high IQ in their family, you can get them to IIT and then get them out of poverty. Dakshana has sent north of 1,000 kids to crack the IIT entrance exam and gain acceptance. About 70% of our kids every year make it through. We have about 800 kids in our program at any given time, and we are scaling that. I think by next year, we’ll be at 1,100 and then we’ll keep growing from there.

Madaan: Congratulations on that success.

Pabrai: There’s a great team.

Madaan: One final question and then we’ll roll it out to the audience. Could you give three book recommendations? I know you read a lot, but I’m only going to ask for the top three. They must be other than Poor Charlie’s Almanack and the Buffett biographies.

Pabrai: Here are two of the books I’m about to send to Warren and Charlie. One of them is called The Beak of the Finch by Jonathan Weiner. It’s an old book, published about 24 years ago.

Madaan: It’s Charles Darwin related.

Pabrai: Yes. I was fascinated by the book. It’s about a couple of researchers who had spent several months a year on one of the small islands in Galapagos. They did this for more than 20 years. To their surprise, they saw evolution in real time. It’s something Darwin didn’t see. That’s a great book, unrelated to investing, but it’s a great read. The second one is Am I Being Too Subtle? by Sam Zell. I recommend you listen to it rather than read it. It’s a good way to kill time on the Bay Area expressways.

Madaan: It’s in his own voice, right?

Pabrai: Yes, it’s in his own voice, his raspy Sam Zell voice. I’ve been listening to it in my car, and there are a lot of lessons for investing, operations, culture, and other things. Sam is candid and in your face. The third book, which I’m re-reading and I’m learning a lot from, is the other biography on Charlie Munger, Damn Right. It came out [almost two decades ago]. There’s a lot of good stuff in there, especially some of the evolution Warren and Charlie went through from buying cheap assets to focusing on better businesses, so there are a lot of lessons there. In many ways, Charlie Munger got dealt a bad hand, a far worse hand than most of us are dealt. He endured the death of his nine-year-old son, blindness in one eye after a cataract operation that went south, and then the extreme pain of eviscerating that eye. You can see a lot of human qualities in that book where he’s been stoic about his pain and suffering. In fact, he’s absolutely rational about his eye. He said at the time of the procedure there was a 5% chance of complications. His rational side said 1 out of 20, I’m going to get it, and if it happens to be me, that’s the way it is.

Madaan: What does your average day look like?

Pabrai: One of the things I learned from Buffett is to not put stuff on the calendar. I like to have a free day. I usually sleep late, so I usually roll into work late, usually past 10:00. I don’t have an agenda. I have a lot of different reading materials I’m going through. I’ll see what comes in during the day, and then decide how I want to spend my time. One of the things I’ve added recently is spending seven or eight days in India. I usually fill those days meeting companies. In the meantime, I’m trying to learn more about these businesses before I go meet the people. Some of that directs some of the reading. But that’s how the day is structured: Not a lot of things appear on the schedule and I try to keep it as free form as I can.

Madaan: And you don’t have a McDonald’s on your way where your order depends on the market?

Pabrai: I do have a McDonald’s on the way. I do sometimes pick up McDonald’s. I have never tried to calibrate the spending base of the market. I leave that to Warren. I take a nap every afternoon. Afternoon naps are great. I am refreshed, so by the evening I can spend more time reading.

Madaan: Does most of your reading use electronic media?

Pabrai: Oh, no, I don’t read electronic at all.

Madaan: Tell us why.

Pabrai: That’s a preference. Even most of my emails don’t come to me. Even if it’s addressed to me, it goes to my assistant and they get printed out. I get all my emails at 11 a.m. I get a folder every day at 11, and the folder has anything I’ve got to look at, any mail, emails, things to sign. Whatever is required in terms of any admin, it all shows up in a folder at 11. By about 11:15 or 11:20, I’m done with responses. My responses are usually chicken scratch. You’ve probably gotten some of those, right? The chicken scratch right on the thing is not easy to make out.

Madaan: It’s not easy to make out what you scribble.

Pabrai: Sometimes they bring it back to me, and I can’t read it myself. That’s bad, but it doesn’t happen too often. I agree with Charlie that the multi-tasking we have going on today in society is a net negative. You’re trying to do three things. You don’t get to deep thought. I’m trying not to do that. That’s how I’ve structured it. Warren and Charlie are even better than that because Charlie doesn’t even have a computer. I don’t think he has a cellphone, either.

Madaan: Mr. Buffett sent one email that got into public domain later.

Pabrai: Yeah, the one email became part of the Gates antitrust. He decided after that, that was the end of his email writing days. He’s done three or four tweets. He’s done a few tweets, so he’s getting there.

Madaan: All right, thank you. Let’s open it up for audience questions.

Participant: Mohnish, can you share your insight on the way market has reacted to the new administration? To me, it’s counterintuitive. Most corporations are opposite to the way government is functioning. And still, after we have a new President, the market has gone gangbusters. Planning is something the new administration is lacking. And to me, things like growth don’t happen as an accident; they require lots of planning. Any insight on that?

Pabrai: The first thing is there is not much I can gain from having insights into what the market has done or will do. I’m not making market bets; we’re not trying to figure out when to buy or sell the S&P. Quite frankly, that question is, for me, not relevant because it doesn’t matter. Yes, we’ve had a rally since Trump’s election, but a bigger underlying story may be that if interest rates stay low for an extended time, then present valuations might be a bargain. The stock market might be cheap. Of course, we won’t know that until we get to 2020 or 2025 and see where we are. Markets are discounting mechanisms. If the market has a crystal ball which tells it where interest rates will be in 2025 or 2030, then you can get to some numbers accordingly.

The best I can tell about the market is that there are few bargains. There may be things that are fully priced, there may be some things that are overpriced, but I don’t see things being egregious in the sense that I saw valuations in 1999 and 2000 that were egregious like Pets.com. We lived through that, or at least I lived through that. But today, when you see some of these companies with these huge market caps like Alphabet or Amazon or Facebook, there are many reasons you can use to justify that. There’s a lot of underlying logic which didn’t exist with Pets.com. There is premium pricing on some assets, but perhaps all the assets deserve premium pricing. The best thing is to ignore the market because it has no relevance and focus on the minutiae, specific businesses, specific stock prices, and hopefully, low single-digit P/E.

Participant: I was surprised to find out you and Buffett still used those books to look for stocks. These days, it’s so easy to find information. You can go to Gurufocus, use the stock screener, and find P/E one. You can do that in half a second. Why does that still work?

Pabrai: That’s a great question because in 2006, when he invested in Daehan Flour in Korea, you could have had Capital IQ. You could have run any screen you wanted. It would have popped up all kinds of companies. If you believe there are tens of thousands of people with lots of assets who have Capital IQ subscriptions, that stock should have not been at that price. It’s like the dollar bill on the ground where the professor says it can’t be a real dollar bill. In an efficient market, there won’t be a dollar bill on the ground. The reality is that speed of access to information is not the determining factor in leading to market efficiency. Markets, because they are action driven and because there are humans involved, vacillate between fear and greed. At that time in the Korean market, for whatever was going on then, there was more fear than greed. I find, for example, even today there are lots of bargains in South Korea.

Madaan: Can you give an example?

Pabrai: We’re buying right now, so we can’t quite go there. I’m barely able to get $2,000 a day off the stock. And we have a $500 million or $600 million portfolio, so we are nibbling. We’re buying things at 2.5x earnings. For example, I’ll send you on a treasure hunt. A treasure hunt is more exciting than giving you the treasure, right? It’s always better to hunt for the treasure. I have an insight, and I don’t know whether the insight will be right or wrong. You can tell me. We know there are lots of permutations and combinations of changes happening in the way humans travel. We used to have cars and public transport and taxis. That was it. Today we have Uber and Uber Pool. You might get to autonomous with Waymo. Some of you might be familiar with Via in New York, which is great. The result is that humans have a lot more options available for transport and mobility, and the price is coming down. Also, you have low gas prices. It is an absolute certainty in my mind that per capita miles being driven in some public transport for humans is going up. I remember when I was a student, I had my bicycle and mobility was restricted. I was poor and didn’t have a lot of places I could go. With my kids, they could go anywhere. If miles driven per human are going up, how can you play that? One way you can play that is with tire companies. No matter what happens, I’m almost sure there’ll be more tires sold 5 or 10 years from now. If we get electric cars to take off, they warrant weight reductions. They make those tires paper thin. You know that the Teslas and the Leafs have these special tires which don’t last long, and they cost a lot because they want to keep the weight down. Those are even better for the tire companies. They keep wearing out fast. My take was that tires will do well. I made an investment in a company in India which was cheap; it makes the rubber that goes into tires. That will do well. The other was a company in Korea which is, in one shape or another, in the tire business, and it’s growing. Even without these demographic things happening, it will still grow. If I’m buying at 2.5x or 3x, in three years I’ll have all my cash back. That’s the beauty of P/E of three.

Madaan: It’s a tire-related company in Korea with a P/E of three for the treasure hunt.

Pabrai: Yeah, have fun.

Participant: How do you decide when to sell stocks that have worked for you? Do you short stocks?

Pabrai: I’ve never shorted a stock in my life. I will go to my grave without ever having shorted a stock. I would suggest you follow that same mental model. If the only thing you learn over here is to give up shorting if you are a shorter, then it would be an hour well spent. It’s a great question. Each of us has a limited quota of hundred-baggers that will show up in our portfolio. I have had more than my quota of hundred-baggers that I was smart enough to buy but too dumb to hold. There’s a long list. I used to own Kotak Mahindra Bank in 1994. It’s 150x. I probably got 30% returns after five years and sold it. Blue Dart. There are two hundred-baggers I did capture. I owned Amazon in 2002 at about $10 a share. It was 10% of my portfolio. I got 40% in a few months and I was out. That was great. Anyway, what I have learned is not to sell the compounders when they get fully priced, and not to sell the compounders when they get overpriced. Only sell the compounders when it’s obvious to you that it’s egregiously priced. The big money is in riding the compounders, but you must try to get in on them at a reasonable valuation, and you must be right on the fact that they are compounders. It’s a forgiving business. You can be wrong quite a few times and still be okay.

Madaan: Does that mean that your buy versus hold criteria may not be identical?

Pabrai: It is not identical, that’s correct. This is a difficult lesson for a cheapskate like me. It was a difficult lesson for Warren and Charlie. I think they learned that lesson from See’s Candies. That was a seminal purchase for them. In that case, because it was a controlled business, they could see the way it mushroomed. If you get into businesses where management is exceptional or the moats are exceptional – in the case of Google, you get both, you buy one, get one free – then those are businesses you just don’t want to touch. I met some folks in India in some of these meetings that blew me away. In some cases, I looked at it and said there are tailwinds, but in addition to tailwinds, there’s a phenomenal operator and the price was below liquidation value. Those are all good tenets. That’s what you want to look for. But I don’t buy the notion that you buy your portfolio every day. To me, buy and hold are different, and the cheapskate in me still wants to not pay up. But I was able to, at a point in time, get to where Google was, just at the edge of making it. We’ve made it, which was great. That’s the key. You want to ride the compounders for long periods.

Madaan: Is this operator, by any chance, Piramal?

Pabrai: That wasn’t the one, but Piramal is a great operator. But no, there are many in India who are young with great ethos, great drive. Piramal is an example of a compounder. If you own something like Piramal, I would just ignore the price for a long time as long as Ajay is healthy.

Participant: Earlier you mentioned the best-idea portfolio. I was thinking how that would work in terms of managing positions and bet sizing. I was curious how you think about bet sizing relative to margin of safety and your valuation of the company.

Pabrai: It’s a good question. Bet sizing just gets down to conviction. Part of it gets down to whether it’s other people’s money or your money and where you are in life. If you’re a young engineer at Google, you have many decades of productive earnings ahead of you. The key is to spend less than you earn and put it away into places that make sense. It’s probably a mistake to have in that situation more than 10 or 12 positions. There’s nothing wrong with having money in an index fund or a few index funds. That’s a good way to go. If you didn’t have a lot of ideas then you’re going to sort money away, especially with a 401(k) with matching, you can do that. And then occasionally, when things show up on the radar which are no-brainers, you can switch some of the index fund money into an actual stock idea. That’s how I would do it.