Mohnish Pabrai - 2012 Ben Graham Talk Full Transcript
Well thanks for that very warm welcome Professor George. I won’t attempt to say your last name, I’ll just leave it at Professor George. Many of you may not believe this but this is the first time in my life I’m using Skype. [laughter] I was wondering how it would play out and so on and so far it is working really well. So anyway, it is a pleasure to be with all of you. I was thinking that we have a little over an hour and a half here and I was thinking maybe for the first half we would do things that were my choice, kind of things I would like to share with you, and the second half we can make it more Q&A and such. So maybe it might become two thirds one third whatever but we can play it by ear. I’ll try to get a sense for the energy and enthusiasm the class has. So, I’m going to actually take a very unusual approach in this time. First of all is everything clear? Sounds pretty good?[audience nods].
Charlie Munger talks about this lattice work of mental models, which are a number of things he has collected over a lifetime that have given him a significant edge, both in terms of how to lead a great life and have great investment results. He literally spent his whole lifetime collecting these tidbits and they’re outlined in Poor Charlie’s Almanack – a wonderful book. What I would like to share with you is – I cannot share all of my mental models because we do not have the time for that – but I would like to share some of the mental models I use and have encountered. Many of these I have encountered, even you know a decade, decade and a half before I heard of Warren Buffett and became an investor. But I have found them extremely useful. One of the reasons they are extremely useful is that most humans don’t appreciate them and don’t follow them and some of the reasons why they don’t are still unclear to me. But I have found them very powerful. So I will go through this list – kind of a list of mental models – in no particular order and then we will take it from there and open up for your questions and such.
So, you know, about let’s say this is about 23 years ago – when I think I was about 24 or 25 years old – and many of you in the room have probably not heard of a guy named Tom Peters and Tom Peters was like the Jim Collins of the 1980s. He was a management guru at Mckinsey. He wrote a number of books, one of them In Search of Excellence, a Passion for Excellence, these are management books and are really wonderful books. I read these when I was like 24 or 25 years old and there was one particular story in one of the books – I forget which one – which I found quite stunning. He said, and this is a true story, there was an intersection in California, a busy intersection, and there were two gas stations diagonal from each other at this intersection. And they were both self-serve gas stations – basically people just pulled up and would pump their gas, pay, and went on. At one of the gas stations the owner would come out maybe once an hour or hour and a half, pick a random car, and tell the owner “listen, sit in the car. I will pump your gas, clean your windshield, and give you a full service for no extra charge. Same price as the self-serve.” And the guy, his competitor diagonal across the street, can clearly see what is going on because it is very visible to him that this guy comes out every hour, hour and a half, and does this. And he says to himself “this is stupid. You cannot do it for everyone so why do it for some random people”. It is a self-serve station so people don’t even expect it. And what he did is he never made any changes to the way he ran his business. He ran it the same way. But the guy across the street was providing extra service so over time the guy that was providing the extra service and more and more cars were going to him. Even after his competitor saw that his business has gone down there was still no change in behavior. He still ran his business the same way and he kept seeing his business go down. He knew why it was going down but he never made a change or an adjustment. And then Tom Peters made a comment after that. He said that you can sit down with your most direct competitors, and you can openly tell them all your trade secrets, all your kind of hidden techniques of doing things, just lay it all out for them and tell them “you can ask me any questions about the business. I am happy to share with you”. And he said that after you do all that it will make no difference to the competitive landscape because your competitors will listen to you but will not change anything. And so I found this very peculiar and I was 24 years old at the time and I said “this cannot be true”. I cannot believe that someone will tell you how to improve your business and you can see how it has an effect and you ignore it. I said I’m going to basically look to prove Tom Peters wrong. I have been trying for about 23 years to prove him wrong and I said I would prove him wrong by two different ways.
The first way I would prove him wrong I said was that when I see something smart being done by some other business or competitor I will force myself to adapt it then that proves that Tom Peters wrong that at least one person is taking ideas from another business and improving their business. The second way I will prove him wrong – I’m going to learn in business when I see examples of people cloning good ideas. When I went through and copied great ideas – at the time when I read this book I just started an IT services company, and I ran that company from 1990 to 2000, about ten years. Over that period that company was quite successful. I started in the bedroom of my house and we ended with about 170 people.
[i]And basically as I ran that business, I basically lifted ideas left right and center from every place I could. Anytime I saw someone doing something smart in the industry that applied to me I would adopt it and I saw the benefits of doing that.
But what I also noticed is that I was in a business with very high turnover. I had a lot of primadonnass who used to work for us. All these IT guys. And we had very high turnover where many of them would leave and because there was so much growth in the industry, they would set up competitive businesses. So they would come in and see me, look at their shoes and put in their resignation. I would ask them what their plans were and they would sheepishly answer that they were going to compete with me. And of course I used to smile at them and say “listen, is there anything I can do to help you compete with me. Anything at all.” And they thought I was kind of pulling their leg and what they didn’t realize is that I was testing the Tom Peters theory. And repeatedly I noticed that sometimes when they even asked me some questions about the aspects of the business, and I would give them very candid answers about how they might go about it and how we did it. Later when I observed the way they ran their businesses they did not take the advice. Repeatedly I have found that the Tom Peters principal that most of your competitors will ignore what you tell them was true.
And I studied this whole area of cloning. This is what I call being a cloner. So this area of cloning – and I still haven’t understood why humans have such a hard time cloning great ideas. Humans seem to want to keep looking for new ideas but there are so many good ideas around that you don’t really need to create your own ideas, you can clone them. What I have found is that some of the greatest businessmen on the planet – people who have the highest level of success – were complete cloners. They were not really smart people but they were really good at cloning. These guys were kind of the exception to the rule. For example, Sam Walton who started Walmart. People who knew Sam Walton really well would tell you that this guy was not a brilliant guy. He was not a super smart guy. But what he did was is he spent an incredible amount of time in his competitors stores. He was looking at every single thing his competitors did all the time. If you look at Walmart for the first 10 or 20 years, every single thing about Walmart – there is no innovation in Walmart. Walmart is simply lifting the Sears model, the K-Mart model, retailing models that existed for decades before Sam Walton came along. There is very little that Sam added in terms of his innovations to retailing to Walmart. And it was extremely successful.
[ii]If you look at Microsoft and Bill Gates – Anything that Microsoft had any kind of success with has been cloned. The Company has never produced any innovative ideas that have made any money. They have produced innovative ideas that have lost money. But you know, Windows was lifted from the mac. Word is lifted from Word Perfect. Excel is lifted from Lotus. The Zune is lifted from the ipod. Explorer is lifted from Netscape. I mean, you know, Money is lifted from Quicken. Across the board the company has a DNA structure of simply being a cloner. And you know they are not even very good at cloning. The first, second, third attempt is terrible. In the eighth, ninth, tenth attempt they try to get it somewhat there and they do pretty good. You ended up creating a business which created some the richest people on the planet.
If you look at something like Burger King in the fast foots space. McDonalds has this huge department and extremely precise approach to figuring out new locations for new McDonalds. They do a lot of rigorous studies and the figure out exactly which locations will have the best likelihood of success and they open those locations. What Burger King does is they’ve got two guys who figure out locations. All they do is put Burger Kings right next to McDonalds. And basically the company spends no time figure out what is the most ideal location.
And if you look at me, someone like me who is just a total shameless cloner – no innovative ideas – you know I don’t even know why you are listening to me because I have nothing new to share [laughter]. All I’m going to do is take all kinds of ideas from other people. So if you look at me. I heard of Warren Buffett for the first time in 1994 and I was very intrigued. This is an incredible way to make money. You just sit there and pick some stocks and you don’t even have to run the company. Some other yoyo runs the company and you make the money. This is wonderful. [laughter] So I started to apply Buffett’s approach in 1994 to investing with my own money. I had about a million dollars in cash at the time. And I did really well. I think from 94 to 99 I had something like 75% annualized returns. Then in 1999 a few of my friends who I used to give stock tips to, they asked me “hey can you, instead of giving random stock picks, can you just manage some money for us so it’s a little more systematic. Where you can buy the stocks when you feel like it and sell them when you feel like it; www.canadianvalueinvestors.com And you don’t need to give us stock tips because if you give us stock tips sometimes you do do something and sometimes you don’t do something; Sometimes I don’t see you for awhile and so there is a lot of randomness. I said I am happy to do that but I want to set it up in a manner that is similar to the way Warren Buffett set it up. So what I did in 1999 is I set up Pabrai Funds but before I had no original ideas of my own; I went back and looked through the Buffett partnerships, which was run from 1956 to 1969. And basically I found this attorney, and he turned out to be a useless in hindsight, he was a real estate attorney – and I told him “setup a partnership structure like this guy Buffett had set up” and he did. It took three times the money to fix all his problems but later on it was fine. Here is what I found which was extremely insightful for me; the Buffett partnerships ended in 1969. Pabrai Funds started in 1999. Over that thirty year period I could not even find one investment operation anywhere in the world which followed the Buffett approach to running a partnership. And I found that amazing and a huge validation of the Tom Peters principal that people just don’t want to clone great ideas. Here you had a guy proven probably the greatest investor of all time, who ran a highly successful investment partnership, made a lot of money, and basically he put $100 into that partnership and I think thirteen years later when he ended it he more than $30 or $40 million dollars that he earned on $100 million of capital. It was incredible. And he did it in a manner where he charged no management fees. He had a 6% hurdle.
So I copied all those things. No management fees. The 6% hurdle. You know, reporting once a year. So I could not find a single fund that was willing to run a Buffett partnerships style structure which is 0% management fees and 25% of the upside after a 6% return. That structure did not exist. And I couldn’t understand why it didn’t exist but I told the attorney “listen I don’t know the way hedge funds are running – I knew nothing about the hedge fund industry at the time – just wanted to clone what Buffett did. And it took me about two or three years to figure out after Pabrai Funds started that all these things that I blindly copied from the Buffett partnerships actually gave me a tremendous moat that nobody could cross. My competitors could not cross that moat. So the thing is Fidelity Investments or any of these you know large hedge funds, they have significant staff. At Pabrai Funds our office closes at 2 o’clock. Right now I’m here in our conference room there is no one where; it’s just me. And in fact normally at this time I’m sleeping – I have a nap room in the office [laughter]. Today I had to take my nap a little bit earlier so I didn’t fall sleep while talking to you guys. But I had a great nap and I’m in great shape now [laughter]. But anyway, the thing is that one of the things about the way Buffett ran his partnerships and even the way he runs things today is he does not delegate any aspect of the investment process. There are no analysts. There are no associates. I think now he has one Harvard grad that helps him out but I think she’s doing stuff on fixed income and stuff. But basically he runs with no help whatsoever. So when he makes the IBM investment, or the Coca-Cola investment, or the American Express investment, or the [unintelligible] investment – 100% of the work, 100% of the reading is done by him. Nobody else. No analyst is feeding him anything. So if you run an investment operation where you do not have any staff, what that means is you have no expenses. And you have no expenses you can get away with charging people no management fee. But all these other investment operations – even if they manage $50 million or $100 million, they have an army of analysts and partners and all this stuff going on. I don’t even know what they do all day. In fact I told my staff and even my investors that we probably have very little to do for the next couple of years. We made all these bets, they are all undervalued. Now we just have to talk to students for the next two years [laughter] till the stocks go up in value. Then we will have something to do that at point. So really we have nothing to do at this point.
So anyway, the cloning thing – what I wanted to just tell you was that even what Pabrai Funds did is I cloned the Buffett partnerships and the power of cloning significantly increased the net worth of my family. It was extremely good for the investors who gave money to me. And we run in a manner that is – in a matter of fact I have discussed this model with both Warren Buffett and Charlie Munger, I have met them both several times about this – and they have quizzed me about this particular aspect – especially Charlie Munger – quite a bit about it. And they – I can see they really appreciate that finally someone came along who cloned them. And it was just good to see that. And another aspect of cloning is that – you know, when you run an investment operation it’s really very simple. Here’s kind of the basics of investing, which you already know but I will bore you for about five minutes on it. First of all, if you know nothing as an investor – you know, a total idiot – then you can just invest in index funds. And by investing in index funds you will probably beat 70-80% of the crowd anyway with very little frictional costs. So you’re already ahead of the game. Let’s say you’re a little bit better than the village idiot. You’re not completely IQ of 50, let’s say you’re an IQ of 70. If you have an IQ of 70 what you can do is instead of buying an index fund you can just buy Berkshire Hathaway. The odds are pretty high that if you just buy Berkshire Hathaway stock you will beat the indexes and are probably beating 90% - maybe even more than 90% - of the investing public. Now we have no work to do. You buy the stock and maybe go and play golf for the rest of your life. Done. So that’s the second thing you can do with an IQ of 70. Now let’s say you’re endowed with an IQ of 90, you know – which is way below anyone in this room – but if you get to an IQ of 90 now what you can do is, in fact there were two professors and I think they were at Ohio State.. George might now, I’m not sure. They did a study and what they found is that if you bought a stock that Warren Buffett bought and you bought it was after it was publicly known that he bought it and you bought on the last day of the month that it was publicly known that he bought it, and you bought it at the high price of the last day of the month – Let’s say it came out in early November that he bought IBM, so let’s say you bought IBM at the high price of that day, and you hold IBM until he sells it. And when he completely eliminates the position, you sell it on the low price of the last day of the month when it is public that he sold it. And he just did this – this is the algorithm you’re following – this is the highest level of cloning Buffett, right? You just coat tail him. So when you know he bought something you go buy it on the last day of the month and you be a total idiot and take the high price on the last day. And you sell it when he sold it on the last day – you beat the S&P by something like 7 percentage points a year. OK? So now you’re not just beating 90% of the crowd, you’re beating like 95%, 97%, maybe 99% of the crowd.
The thing is that in order to set up a great investment operation the number one thing is simplicity and the number two thing is to clone. You don’t need – In this approach of copying and coat tailing Buffett, there’s no need to take Professor George’s class, you’re done right now! [laughter] Go out right now and you’re ready to go. You don’t even need to listen to the right of my boring lecture. So anyway, those are the two requirements. If you feel like you’re endowed with 100 IQ, 125 IQ, 150, and you feel like you’re ready to do some work to be productive in society then what you can do is you can set up an investment operation which simply buys what the great investors have bought. So for example, yesterday a whole bunch of 13Fs came out. My 13F came out, Buffett’s 13F came out, Prem Watsa’s 13F came out. All kinds of 13F came out. Right now I’m orgasmic looking at 13Fs, OK? [laughter] So with these 13Fs, I go through them and start reverse engineering them. I’ll give you one. There’s a guy – I haven’t even done the work on this so maybe you guys can do some work and send me some synopsis of this as its kind of incomplete, so I’m giving you real time what’s going on Pabrai Funds right now, it’s really exciting like watching paint dry [laughter] –
There’s a guy who came on at Berkshire Hathaway as one of the two outside managers who’s now part of Berkshire Hathaway – these two guys will eventually manage the investment portfolio. Todd Coobs came on board in January of last year and in January of this year Tedd Weschler came on board. And he probably came on board, unless Todd copy his picks, he may have come on board just before the end of the year because what I noticed is Berkshire has a brand new position that they have never owned before. It’s called Davita. Davita runs kidney dialysis centers and they’re probably the most dominant kindey dialysis center in the U.S. – and in fact they just starting to go overseas – I don’t know a whole lot about them. I just started reading up on them yesterday, I just pulled up the latest annual report yesterday. And I started reading up on them because what Tedd Weschler has done – I had looked at Tedd Weschler’s 13Fs when he was named to be going into Berkshire Hathaway because I wanted to understand what kind of things he was doing. And he has had a position in Davita for several years in his fund.
Just like for several years in his fund he had a position in DirectTV. And in the fourth quarter of 2011 Berkshire Hathaway really increased its holdings in DirectTV – It’s holdings went from $200 million dollars to about $800 million dollars, massive increase. Now my best guess is that each of these guys are managing about $2 billion each. I think Todd Combs put about $200 million into DirectTV, which was a Tedd Weschler pick. But Davita may be purely Tedd Weschler, there is about $200 million that has gone into it. Here’s a couple of things: If you’re the village idiot. Today is February 15th, all you need to do is wait until February 29th – I think this is a leap year, right? – and on the high price of that day buy Davita, end of story. No need to do anymore thinking. And then wait until they dump and that’s when you dump it. In meantime you know just go fly kites [laughter]. And now if that doesn’t satisfy all that brain horsepower you’ve got you can be like me, which is let’s start studying the business. I’m going to start reading the annual reports. I already get a sense of what they’re doing. So this is a company that has a very defensible moat. It’s a very essential service. They’re probably the low cost provider – I would guess that they are the low cost provider. They seem to very well run. And they’re buying back about 6-8% of this company every year. www.canadianvalueinvestors.com Massive buybacks of stock going on. It doesn’t seem cheap from a valuation basis but it seems like an extremely good return record. These guys are generating something like a billion or so in EBITDA on a negative amount of tangible value. So the ROE on this business is infinite. Just take ROE even in the [unintelligible] business is approaching infinity because even there the tangible book value is almost negative. So anyway, this is an example of ideas from great investors.
So what you can do since you’re going to Ivey and since you’re spending all this money and whatnot, if you want to actually do work you could self invest an operation, which is simply only taking ideas from great investors, studying them on your own, discarding the ones that you don’t understand – so Davita might be one I don’t finally understand in the end, or maybe it is one that I do understand, we will see – discarding the ones you don’t understand, take the ones that you really understand, take the ones that are absolutely no brainers, and buy those. And that will be enough to get you going for awhile.
So I think the big message I wanted to just meet with you here is that cloning is extremely powerful. If you look at what I did with Pabrai Funds, the structure, the setup of Pabrai Funds – completely clone the model – and then on top of it when I’m actually buying stocks, very few of the ideas – and remember this is just between us girls here – very few of the ideas are actually things that I have generated on my own. Almost all of my stock picks, and keep this quiet, are lifted from someone else [laughter]. I don’t even know why they pay me but, you know, what a country. That’s what I do. I lift. Prem Watsa does all the work, we can lift from Prem Watsa. Warren Buffett does all the work, we can lift from Warren Buffett. Tedd Weschler, Marty Witman. You know, all these guys. These are fantastic guys and you just keep lifting ideas from them. God bless the SEC for 13F filings [laughter]. So that’s cloning.
The next mental model – I call it the secret [30:00 mins]. Now this secret is not like the book the Secret. It is even better than that. The secret – and we will just keep it between us, don’t let the secret out. Dr. George are you going to put this on the web? “Yes” Okay, good. So the secret will be out but at least you got it first [laughter]. So the secret is that – normally I ask this question in a Q&A format so maybe I will ask this question and maybe one of you can come up to the mic because you have such high IQs and give me the answers. How many hours are there in a week? Maybe the guy in the jeans in the front in the white shirt, is that a white shirt? Yeah. The white shirt. Can you come up to the mic and answer how many hours there are in a week? If you don’t know, ask your fellow students. “I think I’ll take an answer from the audience. 168.” OK just keep standing there because I have more questions for you [laughter]. There are 168 hours in a week so how many hours is a typical full time job. “40 hours”. Right. How many hours are left over after you work 40 hours. “128”. 128. OK. Alright, can you sit down? The math skills are just up there because, you know, we have been doing all this high math here on the secret. So anyway, so you saw that there are 128 hours left. You know, people come to me all the time saying, you know, they’re going to start their own business or start their own fund and they’re going to go quit their jobs and do this and that. And I find that really stupid.
First of all, when someone is paying you 40 hours a week, what are they paying you for? The good news is they are paying for your rent. They are paying for your groceries. They are paying for those nice pants you have on. They’re paying for everything. Okay? And let them keep paying for it. Don’t stop the cash flow. So, if you want to start a business never start a business with saying “I’m going to quit and then start the business”. What you do is a few tweaks to the way your lifestyle works. Number 1: live really close to work. I live 5 minutes away. The 40 hours is actually 40 hours. You don’t spend another 20 hours commuting. Okay, so live really close to work. Number 2: Stop working extra hours. You know how sometimes you’re trying to get ahead and you work 50-60 hours or 70 hours. We’re done with that, okay? What you do is you just work enough so you don’t get fired. [laughter] And I’m just telling you this is my life story. This is how I started my business. I was this guy that was getting all these great reviews, etcetera, and then I finally decided when I was 24 years old I’m going to start my own business. The first thing I did is “to hell with the reviews. To hell with the reviews. All I need to do is just barely keep it so they don’t fire me.” So I took it way down, exactly 40 hours, minimized, etcetera. And what you do is – what I had done when I started my first IT business, I had no money.
So first of all, one part of the secret is you do not need money to start a business, okay? There are venture capitalists, in fact for me the venture capitalists were VISA and Mastercard – these venture capitalists are willing to fund you completely with no equity. They don’t even want any equity. They don’t even want any business plan. This is fantastic, what a country! [laughter] What I had done is basically when I was thinking of starting of business – first of all I applied for every VISA and Mastercard I could get. I think they have become wiser now and changed the laws. But in 1990 at least in the U.S. they had this law that if you declared personal bankruptcy – they would look at your situation and say “is he really bankrupt?” – once they were satisfied you had no assets and whatever else, basically you got everything cleared, basically a write off for your lenders, and you could not refile for seven more years. Which means you actually became a AAA credit for the next seven years because the lenders know they can’t get hosed. So actually after you file – and I think they’ve changed this now – but for the longest time – I remember researching this when started a business, that after you declare bankruptcy your credit dramatically improves. And everyone wants to lend to you because they know they can’t get hosed again for awhile. So what I had done is, I had no money, I wanted to start this IT business, I applied for every VISA and Mastercard, and at that time they sent you all this stuff in the mail all the time. I don’t know what happens now. Maybe it’s changed now. And I had 20-25 credit cards that I socked away.
And what I did is every time I needed money for the business I just went and, you know, maxed the cash advance on that credit card and, you know, just kept running that way. And I think I emptied out my retirement account at that time, about $30,000. So I have taken about $70,000 in credit card debt, $30,000 from my retirement plan, and of course at 24 I wasn’t worried about retirement. And I was not married, I was single. There was no obligation.
That’s the other thing – the age I can see from most of you, you know, you have a lot more hair than I do – so most of you are way younger than I am. And so I think you get a free one shot very early in your life when you have no family, no kids, no nothing, and no assets. The good news is when you are early on in life when you have no assets, it is the best time to declare bankruptcy. So my thinking was I could completely blow up, lose everything, and it would not affect anything.
So I started my business in February 1990 while I was working full-time for this company. What I used to do is get up very early in the morning – around 6:00, 6:30 - and I would work right up to 8:45 in the morning and then I would drive to work and get there at 9:00. And then exactly 8 hours – you know punch the clock – at 5 p.m. and I would leave. And remember for about a year I ate subway sandwiches because it was just so fast. And basically from 5 to midnight or 1 o’clock I would work and of course weekends were for working as well. So basically I had at least another 50-60 hours that I was able to work besides the job I was doing. Then the sleep and everything else I wanted to do. And of course I had VISA and Mastercad that was backing me up completely. Then when the business actually had some revenue, it took about – I was very young and didn’t have much experience – it took me about ten months to get the first client. Because I used to go and hit my head against a lot of brick walls trying to figure out a model that works. Your clients actually teach you. You say X, and then they say “no I want Y”. And so you listen very carefully to what they are saying and you adjust your pitch. That’s what I did. I just adjusted my pitch to the point that my clients really taught me what business I needed to be in. And so, a year later, I think January of 91, I had enough – I had two clients – and I had about three months of cash flow, which was more than what my salary was and after three months was no visibility. But, you know, I was dying to go full time and I was dying to basically just do this completely. And I felt like if I could just get all my time in the business I could really grow it.
So I went in in January of 1991 to my boss’ office and turned in my resignation. And he and his boss, who was the President of the company, they sat me down and said “we finally now know what happened to you the last one year because you just turned off. And you were not so bad that we wanted to fire you but we just couldn’t get output out of you.” And I said “BINGO, that is exactly what I was trying to do!” [laughter]. And so they tried to, you know, give me a raise and this and that, keep me interested. Then they made me an offer; they said “look, when you’re business fails” – not if your business fails – they said that “when your business fails, come back and we will give you this massive raise and you will get this higher position and you don’t even need to look for a job. Just next year you can start working.” So I said “wow, what a country. Here, you quit. You go and do your thing. You can declare bankruptcy. And the next day you have cash flow back in at a higher salary and everything”. And of course, I never went back to them. The business never failed, it actually did fine. And ironically about ten years later when I was starting Pabrai Funds both of them became investors and they are still investors.
And so the secret that now you all know is: 168 hours, only 40 hours required for the yo yos to pay you. The rest is your time. It is more than enough time to get a business off the ground. You don’t need money. And especially now, you know, with all of this internet and online. If you do the money management business you can run it out of your bedroom.
When I ran Pabrai Funds in the early days when I was raising capital, basically I didn’t even have three chairs in my office so no one could actually come to the office and meet me. What I did is Starbucks was the office. And the great thing about Starbucks being the office is I had offices all over the place. So I would go to San Francisco and I would sit in Starbucks and I would have like every half an hour a new person in front of me, and line up 15 guys one after. And of course I would be very heavily jazzed up by end the evening with, you know, 14 lattes into me or whatever. But the assets came in and there was no problem. So that’s the other thing, which is keep in mind the secret when you want to do your own thing: Don’t quit your job and do all those stupid things. And try to do it early.
One thing Charlie Munger told me sometime back that I found very interesting – he said that when you look at all the scientific accomplishments of all these people, almost all of them happen early in life. Very few scientists have breakthroughs later in life, even though they have more experience and more knowledge. And the reason is that they get set in their ways and it is very hard for new ideas to step in. So it’s the same thing actually that even – you know, one of the things about our education system is that the teenage years, the adolescent years, are the most creative years for humans. And those are the years where one needs to specialize and go all in on what they want to do. And of course what our education does in those years, it does the exact opposite. It forces you to broaden out very heavily and take all these courses you have no interest in in high school. And of course be the end you finish all that and go to college and all that and it is over and that beautiful period of high creativity is gone. So if you look at people like Warren Buffett, you know, he starts at this at the age of 11. If you look at Bill Gates, again very early in life. 11 or 12 years old when he started programming and all that. And if you start studying Steve Jobs and all of these people, a lot of their early impetus came in the teenage years. And even in my own case I got lucky that my father was an entrepreneur and he used to have a lot of trouble with these business and they went bankrupt many times. In fact, I felt like I finished my MBA before I was 18 years old. But from the age of 13 to 19, I spent an incredible amount of time in my fathers business. Sales calls with him. Running the business day to day. All kinds of things. Helping him with his financial cash flows and all that. These things were extremely tight and we were trying to figure out how to get passed the next day with all these people, you know, the wolves at the door who want to get paid, etcetera and the business is going under. So its initiation by fire. But those years, the 13 to 19 years, working with my dad – I know that today it makes it very easy for me to figure out businesses because of the work I did at that age. In fact if I did the same work even ten years later it would not have had the same impact. I think the wiring of the brain is different at that time. So the earlier you start the better you are at doing it.
So we are going to go to another area – how are we doing on time? What I will do is, I don’t want to take all of my time on mental models, so I will do one more mental model and then maybe we will go into Q&A and see what’s on your mind.
So this is what I call the Hare Krishna Flower Mental Model. We talked about be a cloner, the secret, now this is the Hare Krishna model, and these are just gems that you cannot find anywhere. I think this is from Cialdini’s book Influence, some of you might of read that book. Maybe raise your hand if you have read that book. Oh come on, just George? Maybe you can pick up that book – it’s a great book. There’s a story in the book where – and this is before 9/11 – and they used to let people come up right to the gate of an airplane when you went to receive someone. There was no security like the way we have today. So, in Las Angeles you would have these Hare Krishnas dressed in all the orange garbs and whatever else, and they used to be roaming around the airports. And they were allowed to go right up to the gate. And they would look for people coming right off the flight. And when people were coming off the flight, they would like to identify someone dressed like Dr. George – you know, business man, suit and tie, all that stuff – and they know that this guy is the perfect customer for them. They would see Dr. George come of the plane and this Moonie would immediately attach himself to Dr. George and start walking with him. And he’s go his orange robes and Dr. George is trying to get to a meeting. And he would say “Hey sir, isn’t this a wonderful day? What a beautiful day, a nice sunny day. I would like you to have this flower” and he has this beautiful flower. Some kind of tulip or whatever else. Or a rose or whatever. And just give it to him. And of course George there has no interest in the flower – he just wants to get away from this guy. And he says “no I’m not interested”. And he [replies] “sir there’s no obligation, no money, nothing. I just want you to have a flower.” And George is walking trying to ignore the guy – he just keeps imploring “please take the flower, please take the flower”. Finally, one out of ten businessmen – just to get rid of the guy – take the flower. Now once you take the flower you are hosed, okay? Because once you take the flower, what has happened is signals in your brain which are set up for reciprocation, get triggered. And because most of us are not assholes, you do not want to take a favor from someone without reciprocating. So what happens is you reach into your wallet, take out a couple of dollars, and you give it to the guy. And as soon as he gets those few dollars he is history, he is gone, okay? He’s only about ten paces behind you. And as soon as you come to the first trash can and drop that flower in the trash can, he is right behind picking up that flower. And he picks up the flower and goes back to the gate looking for the next Professor George. This goes back – and I think I know why this is in humans – this goes back, way back, you know to cave man days. So what happens is you’re a hunter and you’re living in this small community of hunters. And you have a really successful hunt, and you bring down the big beast. www.canadianvalueinvestors.com And the big beast you brought down is way more meat than your whole family can consume. And so what you do is – you cannot refrigerate this, there is no refrigeration – so what you do is store it in the stomachs of your neighbors. So you call the whole tribe and say “hello tribe, I am benevolent, and I brought down this big beast. Please feel free to feast yourself. And the tribe is very happy and everyone has a good time. But what is happening is, the message you are sending, when you bring down the big beast, and I am starving, call me. And of course, humans are set up to do this reciprocation. But there’s a problem in our brain circuitry on the reciprocation. And the problem is that there is no calibration. So the thing is that if I do a favor for you, your brain knows that I have done a favor for you. Just like if I feed you meat, you know I have fed you meat and you need to return that. But your brain is not able to calibrate the size of the favor.
So let me give you an example of how this calibration being off was used by me when I was scaling the assets of the fund. All these investment funds, when people – you know high net worth individuals – will contact them and say “hey I’m interested in your fund. Can you send me some information?” All these idiots would send the information as a PDF. Pabrai Funds has never ever sent anything like that in an electronic format, okay? What we always did is we printed these documents, bound at kinkos, nice spiral binding and all that, and then create a package – priority mail envelope – where these documents go. And included in the documents - of course a letter from me and all that – is a very very nice Cross pen. It’s a $50 Cross pen, okay? Now, this is even better than the Hare Krishna flower because the Hare Krishna is asking you to take the flower. They didn’t even ask for the pen. It was just shoved down their mailbox without them asking for it. Now you’re some guy who let’s say is worth $10 million dollars, or $20 million dollars, and he’s contacted the fund and whatever else – he may or may not have some interest. And he gets the package and then there’s a pen in the package. It’s a very nice pen – of course he can’t throw it away, it’s too nice to throw away. It has Pabrai Funds written on it. Nice Cross pen. And it’s very difficult to send the pen back. There’s a lot of frictional costs and time involved. In fact I’ve tracked it – probably 1 out of 500 packages we send out where they sent the entire package with the pen back. This is the guy telling the Hare Krishna “F off, I am not interested in your club”. [laughter] And so 1 out of 500 did that, sent the whole package back. But 499 did not do that. They took the flower. Once they take the flower – here’s the deal. You take the flower, you need to reciprocate. How do you reciprocate? Wire a million dollars. It’s the only way you can reciprocate – in fact [the fund minimum ] was $2.5 million. So the thing is since the brain cannot calibrate, I give a $50 pen, you wire $2.5 million. We’re even, okay? [laughter] Lo and behold there’s $600 million in the fund. From the Hare Krishna, from the Moonies, okay? What a great mental model. The thing is humans cannot calibrate. Every year we send out – I tell people when they visit Pabrai funds that Pabrai Funds, the way our office is set up, because you know we don’t work over here, the way the office is set up. It is mainly a mailing house with a small investing business on the side. During Christmas time we send out, I don’t know maybe 1,000, 2,000, or 3,000 books to all kinds of people around the planet. You know, investors, and all that. And they get these books every year. Again, it’s just like the flower. They didn’t ask for the book. They got the book. [Professor George] “I got one from you”. [Mohnish] “Ah yes, see there you go!” [laughter] Now do you feel good towards me Professor George? “Very good?” [laughter] There’s incredible goodwill built up. There’s wire transfers coming in left, right, and center. All kinds of good things happening, okay? The calibration engine is way off so you can just take advantage of that. That’s the Hare Krishna Flower Model. Very important to remember that humans cannot calibrate.
The other - I’ll just spend two minutes - I will not spend time on these – but just some mental models I want to share with you very quickly. One is: Humans do not know the price of anything. So, now this seems strange. But the only way we know the price of something is by comparison. So for example, if I ever ask you “what is the rent for a one bedroom apartment in Calgary?” What you will do is you might go online and start looking at different apartments and, oh it’s about $900 or whatever. But you don’t really know that until you do comparisons. There’s a book called Priceless, which is written by William Poundstone. Great book to read. Now, if humans don’t know the price of anything, and you’re a business that sets price, don’t you think that’s a good thing to know that humans don’t know the price of anything? So, that’s another very important mental model to know. For example, in the investment business they have no idea what I should get paid, and that’s a wonderful thing. [laughter]
And then this is one I lifted from Bill Gates – and again I won’t go into the details of this, but I will just tell you – He says that even if you are a monopoly you have to ask for the order. This is very important in the sense that, at the end of the day – if I meet people and tell them about the fund and all that, that’s all fine, but I have to actually go slightly outside my comfort zone, be a little cheesy, and actually ask them “when are you wiring the money?” Always ask for the order. People forget to ask.
On final thing – Warren Buffett talks about this – If you were told at the beginning of your adulthood, let’s say you just turned 18, you can have any car you want, any car can be yours. But the rule is you have to only have that same car for the rest of your life. You cannot change the car. What will happen is you will be really careful about what kind of car you buy. But you will be even more careful about the way you drive it and the way you are maintaining it. Because it has to last you 70-80 years or whatever. Your brain and your body is the only one you are going to have. We may all think we are going to live forever but guys that’s not going to happen, I’m sorry. Basically what you want to do, you want to basically be what Warren calls a continuous learning machine. Throughout your life you want to take this car and continually enhance the value of the car. And the way you enhance the value of the car is to continuously be learning and improving your mental models and your thinking and your knowledge and everything. You want to just continually ingest knowledge. Ghandi has a quote – in fact we have it in our office – he says “live as if you were to die tomorrow. Learn as if you were going to live forever”. And I think that’s a great way to live life. You think you are going to live forever, that’s your model for learning. But you live as if you were going to die tomorrow.
With that I think I would like to shut the monologue down and see what’s on your minds.
Question: You said work/life balance is very important to you. Was that something you had to learn, or did it come naturally?
Well, I think that’s a great question. My father used to say [in hindi first], “we enter the world naked. We leave the world naked.” What he used to add is that you have got to fill in the blanks between those two points of nakedness. So basically, if you just kind of step back and look at the essence of life if you will, one of the things that matter – I mean if you look at a country like the U.S. – what proportion of the country is starving? It’s close to zero. My father-in-law when he visits the country from Mumbai, he says “the U.S. is probably one of the only countries I go to where poor people are fat.” He’s used to seeing poor people being thin because poor people don’t get enough nutrition but in the U.S. you have the reverse situation where poor people are fat. Quick frankly, at the end of the day this is a country where virtually no one is homeless. Virtually no one is starving. Virtually no one has survival issues. Yet at the same time humans spend an enormous amount of time worrying about those things. “How am I going to make money? How am I going to pay my rent? And this an that.” While at the end of the day on the other side one way or another everything has been taken care of. So it is not worth worrying about. So I think ought to do is focus on things that are more relevant in life. And of course the relationships in your life are very important. Things that bring you happiness and happiness to people around you are very important. And money is a very small part of that equation. And of course being a workaholic is a very small part of that equation. I have always felt that work should be more fun than fun. And both my wife and I have very little craving to go on vacations because – first of all she wonders what I do all day – but basically I am on vacation every day. I think that’s what you want to do. You want to set up your life so that you are on vacation every day and if you are on vacation every day your life will be in balance.
Question: I just want to bring it back more to the investing. What are some the salient patterns you have seen from your failed investments?
That’s a good question. In 2008 I read this article by Atul Gawande on the Checklist, and he later wrote a book called The Checklist Manifesto, which is a wonderful book to read. And basically, he talked about how in fields like medicine and aviation and such, you can get close to zero error rates by learning from the mistakes of others. I think we do not learn anything from success, because your funds are up and everything is fine. You really don’t learn and you just think your God’s gift to earth and everything is fine. There is no learning. The only time you learn is when you fail. In fact, I’m a big fan of Marcus Aurelius the Roman emperor who set up stoicism. I think Marcus Aurelius would say that failure is something you should welcome and cherish because that is your true teacher. So, I learned a lot – in fact I would say there are two ways you can learn. When you go through personal failures, where you direct loss of capital, loss of principal, loss of net worth. Those lessons get seared pretty strongly in your psyche and you’re unlikely to ignore. So here are some examples of those. First is, I have started three business in my career. www.canadianvalueinvestors.com And I started a few others that maybe petered out in a week or something but I won’t talk about them. But three of them went on for awhile. Two of them took virtually no capital to get going. Pabrai Funds and my IT company TransTech, Inc. They took hardly any capital. The third one, which is one called Digital Disruptors, I thought I was really smart at the time. And I put a lot of my capital, a lot of my net worth in it, and I took a lot of other people’s money into it. In fact, it took about $4.5 million of capital and the four and a half million went to zero in a pretty short period of time. I learned a number of things from that exercise. One of the things I learned is when you start a business – I said to myself you idiot – when you start a business, remember don’t put money into it. Businesses to get started do not need money. They need brain power and other things and you could put that. One of the things that got seared into my psyche is that I will probably never ever go into a venture which needs money. And if it needs money I will try to find a way to think about the business in a manner where you can get around it. If you look at Microsoft or Walmart, or any of these businesses, they all got off the ground with no money and became massive businesses.
Then you have other failures. For example, I made an investment in 2007 in a company called Delta Financial. And at that time we had put $60 million or $65 million into the company. And about 18 months later it was zero, it went bankrupt. Delta was in the mortgage space and when the whole implosion of the 2008 stuff happened it just couldn’t make it and went away. And some of the lessons that got seared from that is: 1) Levered financial institutions, you have to be really really careful of levered financial institutions because leverage can cut both ways. And most of these lessons, you’re going to think “what an idiot. Why did he have to lose $60 million to learn this lesson? I could have told him that before he lost the $60 million”. www.canadianvalueinvestors.com And that’s true. Every time you lose money in an investment and you study why you lost money, the answer is extremely basic. And it is something which you should have known, or even a fifth grader should have known, but what happens is that our brains focus on other areas when we are driven by greed. And sometimes we ignore the basics, which is why I have put the checklist in place and use a checklist now. And since 2008 I have an error rate close to 0, I think it is right about zero so far. So some of the lessons of these financial institutions – and I remember a quote after the loss from Delta is, Charlie Munger said this: “You can never invest in a financial services company, you know like a bank or an insurance company, things that are levered, unless you understand the ethos and competence of management.” What that means is that if you are investing in a bank or a financial services company where the guys are unethical. Well, they have a lot of leeway into what they define as reserves and what they define as book value. It’s a judgement call. If the ethics are off you will be hosed because you cannot trust the numbers. And if they are stupid, they may be very honest but the result is going to be the same. So, they not only have to be honest but they have to be competent.
A good example is Fairfax. Fairfax is a levered financial institution. I think it is run by people with a very high degree of ethics and a very high degree of confidence. That’s an area where I feel that if you made an investment like that but your odds of a loss are pretty low.
Question: Going back to cloning. There was an article in the Wall Street Journal, talking about 51 managers including Warren Buffet that they asked from inception regarding their purchases. And that took advantage of [being able to not file a purchase publicly temporarily]. For example, IBM that Warren Buffet recently purchased. It was purchased at the end of the year in 2011, but he started purchasing around March. And asked the SEC not to file the position – “yes they gave him secrecy for that” – exactly. So, another fifty managers, so my question is how does this affect your process?
Completely completely irrelevant. It’s like this. You have all these, let’s say, stores you can walk into, look at everything about how they run their model. And one out of 200 stores is closed, that you cannot go into. That’s not a problem. We also do not know about foreign stocks. We don’t know about things that they buy where the amount they bought is really small. The 13F, even without secrecy, if I buy something where I spend less than $200,000 it doesn’t get reported. Of course, you also have the secrecy rules. I think that is not really relevant because you have such a huge canvas from which you can draw data that the fact that some stuff – in fact, the stuff that is excluded is all hocus pocus. And even IBM. Whether it is excluded or not. I mean look at what happened after IBM stock after they said that Buffett bought, nothing happened. Maybe it had a 1% move or something. There wasn’t much movement. You had plenty of time after that to still act on it. And so I actually think that the fact that some small parts are hidden is irrelevant. You should just ignore that.
Question: Could you share some of your learning experiences from the global crises.
Like I said, learning takes place when you have challenges and you face adversity. That’s the time that the greatest learning takes place. I think some of the growth in that period was, one: The Checklist. That was a very big part of the growth I went through. I will direct you towards the book “The Checklist Manifesto”, which is written by Atul Gawande. I think it is a pretty good book to read. I created a checklist mainly out of other people’s mistakes. Again, this is using the cloning model. Basically, you don’t need to use your mistakes to learn, that could take a long time. You can use other people’s mistakes. I studied Warren Buffet’s mistakes, Charlie Munger’s mistakes, Longleaf Fund’s mistakes, Fairfax’s mistakes. All these mistakes and I made a list. And now it’s 97 and more may be in added to it in the years to come. That is one thing that added was a change that has added huge value because I have seen how much the checklist has helped. The second area is that I used until the fall of 2008, I never spoke to anyone about any investments I made. So I would study things on my own, of course there are no analysts or associates or anyone else over here, and I would make the decision whether I wanted to invest or not. And what I started doing in the fourth quarter of 2008 is I started having really detailed conversations about my investments with one particular manager – he also runs a fund. He’s in a different – what I’m saying is I don’t think we in any way compete with each other. He’s got different clients and everything else. I found that those conversations were extremely for both him and me. Because he would bring up things that I wouldn’t have even thought about, and vice-versa. And more recently, one time when I had a meeting with Charlie Munger he brought up something. He said that in his entire career as an investor, he has always had someone to talk to. It may not have been Warren Buffett or whatever but he always had someone. The power of having an independent – and I think it is important for the person to be independent, I think it is important for the person to not be reporting to you. I think it is important for the person to have a peer relationship with you where they can tell you “this is total nonsense”. They can be totally honest with you with no downside. And the fact that they have an invested interest – And what happens when I have conversations with this person, and we make our own independent decisions but if he doesn’t buy something after I make the decision to buy it, I think about that. I think about why we did that. Because we don’t always agree on everything, but I really think about that. And I have definitely a lot of value in those conversations. I think those are two things that have helped a lot during the financial crises which I adopted and have become quite useful.
Question: My question is about the role of psychology. Professor George talks to us a lot about how it’s very important for value investors to control their emotions, especially in times when stocks are very volatile. I wanted to ask you about your experience in 07/08/09, how you handled that and what advice do you have for people who want to get into the markets.
That is a good question. You know, Charlie Munger says that you don’t make money when you buy a stock. And you don’t make money when you sell a stock. He says that you make money by waiting. And then he went on to say, as far as how long he will wait, he will wait forever. One thing I have found interesting is – there is a public company in L.A. called Daily Journal, where Charlie Munger is the chairman. It is a small public company that basically runs legal newspapers, sells legal newspapers. And from 2000 to 2009 they were generating, I don’t know, $3-4-5 million in cash flow every year. And they kept putting it in U.S. treasury bills. And then in the first quarter of 2009, and not even in the first quarter – he told me it was one day – on one day in 2009 they took that entire pile of cash – I think it was $50-60 million by then – and they put it into two stocks. And both the stocks are bank stocks – I think they were Wells Fargo and U.S. Bank. So he does nothing for nine years, and you know, all kinds of things happen in the market over that time. He’s got all kinds of people telling him all kinds of things. And then there’s one day, suddenly they go all in. The whole thing in one day. And again no actions until just recently, in the fourth quarter of 2011, I noticed in their 13F filing where they again took whatever cash had built up and made an investment. So the thing is over an 11-12 year period, there have only been two periods where they have actually made investments. And so the number one skill that an investor needs to be successful is patience. Because the time frames under which an investment kind of, you know, matures and delivers results is very different from time frames humans are dealing with. And so that is the single greatest advantage that an investor has, is if they have the temperament to be patient. And if they have the temperament of basically, understanding that they are always buying in the circle of confidence, buying things that are dramatically below that price, then waiting until they are fully priced before unloading them. Those are important things.
Question: I realize you are very entrepreneurial. You have talked about the importance of being young and to start early. I have a couple of questions. What was your dream when you were a teenager? The second one is, when you start a business, when do you feel that it is the right time to start it? You’re young and you have no burdens, no assets, which is great, but you don’t have experience and knowledge. How do you balance those?
So the dreams of a teenager. I went through some trauma, I would say pretty significant trauma, in my childhood. My father was a kind of quintessential entrepreneur. He must of started, sold, bankrupted, cloned, maybe 15 different businesses in 15 different industries. He made a Bollywood feature film. He set up a radio station. He ran a jewelry factory. He had a painting company. Interior decoration. Insurance brokerage. Real estate brokerage. A wide range of things. And some of these things – manufacturing speakers for Philips – some of these things actually scaled quite a bit to several hundred people. Invariably all of them at the end blew up. And the thing is that, the reason they blew up, which is clear to me now, is that my father was very aggressive as an entrepreneur. He always saw the glass as overflowing when there was even a tiny amount of water in it. So all his business were always trying to grow as fast as they could and they were highly levered. Max the leverage, max everything. So when the first kind of headwinds started coming in the businesses had a really tough time sustaining. But my father was also extremely good. He defeated even bankruptcy. Bankrupt means the point of not even having groceries for next week. And he would from absolutely nothing start the next business. He would bounce back up. I saw both my parents bounce back up repeatedly. So that actually showed me how people can lift themselves from zero. But the thing is that as a child what I noticed is my parents were very poor financial planners. When things were going really well they spent a lot of money and lived well and all that. When things were going really poorly, we had to really [indiscernible] and ask relatives for money and all these things. As a kid growing through that – I was really traumatized by it. One of the things I wanted was – when I was able to finish my education I became an engineer and got a good job. My goal was to keep that job for my whole life and put 15% of my money into my retirement account. And to let that build over time and to not mess around with ever starting a business. That was my game plan. So actually when I was a teenager that’s what I wanted to do.
And of course my father was visiting me in the States when I started my first job and he started having conversations with me about starting a business. And I started having conversations with him about, hey don’t you remember my childhood. And of course in the end he prevailed and here I am.
Question: Why did you start a business if you wanted a secure job so badly?
Because my father and I had some conversations when I was an adult. And what I was finding was that this job was very stable but had become boring. And so I have a rule that I follow, and the rule is that if on Monday morning I’m not fired up to go to work then I will do two things. Number one, I will not go to work. Number two, I will hit the reset button. And this has happened there times in my career. Each time – in fact somebody recently at my health club told me that they had never ever regretted quitting a job. And so the thing is when something inside you is telling you that you’re not happy with the circumstance or you rather do something else, you have to listen to that inner voice. So part of it was there was a side of me that wanted absolute stability from the instability I came from. But then I was seeing that, hey this stability is coming with boredom, this thing is getting very boring. And then my father is needling me to start a business. And so the combination of all of that – I said OK I am taking the plunge. But what I tried to do was – I tried to do it in a matter which was very different than him where I tried to cover the downside. I covered with you how I went about it, where looked at all the different aspects, I looked at bankruptcy – I looked at bankruptcy so closely because I went through a zillion bankruptcies in India with my parents and I didn’t want to go through that.
Question: The second question was when do think is the right time you think you should start a business, where you balance your knowledge and assets.
The right time to start a business is when you something burning in your heart that is telling you that you have some product or service to bring to the world that will improve the world in many ways. So you have to have something where you are very passionate about it and then you go after it.
Question: I have a question about cloning. You mentioned by simply following these successful value investors we can beat 99% of investors. But I would like to ask what are the things that prevent the 99% from following this strategy?
So is a great question and one where I don’t have the answer. Maybe you can do some research and find the answer for me. Send me an email.
Basically, you know this aspect of people not wanting to clone. There’s a book that came out recently that I read, it’s called Copycats. I don’t think he really got to the essence, but there’s something in the human psyche – which is just like when I talked about the Hare Krishna flower – there’s something in the human psyche and something in our evolution that makes us adverse to doing things the easy way or taking some simple ideas and just running with it. There’s something quirky in our genetic makeup. The few of us who are able to, kind of, transcend that like Sam Walton and Bill Gates, etcetera, you get a massive advantage. In fact in the investing business you see this all the time – no one is willing to clone. If I tell you this method of buying if Buffett buys something and selling when he sells. I have said this to so many business school students, I don’t know anyone, I don’t know any fund even now that is set up that does that. In fact, you, what’s your name? [David]. David! You can do this! There is a clear opportunity to set up a fund where you shut your brain off and just do this. Send your brain to the beach and you will be enormously wealthy. Do it David!
Question: I have a quick question about the cloning technique. A lot of it relies on trusting the funds you are copying. You talk about Berkshire Hathaway, you talk about Fairfax. The questions that I have is a lot of the credibility of those comes with the leadership – so Warren Buffet, Prem Watsa – if you think about those and the fact that they are eventually going to retire or pass on. How do we then identify the next funds to clone? And the reason I ask that is that there are a lot of firms that over a short period of time – 4-5 years – can show aggressive growth year-over-year. But what would you say that is the minimum number of years for you say is the minimum number of years that you would need to see 20% returns, 30% returns, for people to actually trust those to adequately copy them.
I would say that if you have 15-20 years of history behind people that is a pretty good indicator. And not only that. You look at the history and you look at their approach. What are they saying and how are they going about doing it. For example. let’s say something like Renaissance. Renaissance Medallion is, I would say, legalized front running. And I would say don’t clone that. It’s just not worth cloning because it is taking an approach that may not even be legal in a few years, I don’t know. And it just doesn’t fit with what we’re talking about here. But if you look at, let’s say, in Canada there’s a great company called Brookfield Asset Management. There’s a guy named Bruce Flatt who runs it. I think Bruce is an incredible investor and I think he does a great job. I think there are many many guys who are really really good investors. Many of them maybe obscure. In fact, the other reason why this works so well and this is so powerful, is think of it as you are driving a car on a racetrack with bumpers on both sides. Kind of bowling with bumpers. www.canadianvalueinvestors.com When you only basically buy ideas that other great investors have already bought after studying them, the error rate you will have will be a small small fraction of what you would have if you went out on the prairie on your own. If you go out on your own and look at 10,000 stocks and pick ten, trust me your error rate will be off the charts. But if you pick ten out of the 40 that great guys have bought and you have looked into why they bought them, it’s like bowling with bumpers. Never bowl without bumpers when they offer you bowling with bumpers.
Question: you emphasize cloning gives you a competitive advantage over the majority and people don’t want to clone so you have this advantage. Usually say if Warren Buffett buys a stock, investors will follow and the stock price will appreciate it becomes a sort of self-fulfilling prophecy. Of all the investors who decide to follow in this approach, what do you think gives you an advantage over those? Is it just timing?
I think the reason you will get an advantage is because most people don’t have the temperament or the patience. They may buy IBM because Buffett bought it and it may get a bump in price, but they will not hold it until Buffett holds it. They will buy it in November 2011 and by February 2012 they have already sold it, made 10%, and said “I am such a genius”. And that’s the problem. Actually that’s a good question – the thing is that what people do, most people – actually this gene of cloning is very quirky – most people are willing to clone but only partially. They will buy what Buffett buys, a lot of people do that, but they don’t do the rest of it. That is stupid cloning. Half baked stupid cloning. We don’t want to do stupid cloning. You do it all the way. In fact, I was looking at in California we have a burger chain called In-N-Out. So In-N-Out Burger is very very basic, like ten items on the menu, very basic, it looks like you’re in the 1950s – a time warp. And anytime you go there, even if you go there 11 o’clock, 12 o’clock, or 1 o’clock at night, there’s a huge line and the drive through is always full and all of this. A lot of waiting. It’s the simplest model to clone. It’s very basic. No one has been able to clone In-N-Out Burger. It’s amazing to me. If I was in the burger business I would study every aspect of the business and would just shut my brain off. That’s the problem. People don’t shut their brains off. They think “hey I can do In-N-Out Burger but I can add chicken as well. Or I will do In-N-Out Burger but sell alcohol too. Or I will do In-N-Out Burger but I’m going to let people customize their sandwich in five more different ways. No, don’t do any of those stupid things. Copy everything. Copy the signage. Copy the tables. Copy the uniforms. Copy the hat. Copy everything. [laughter]
Question: I have a question when you were starting up and the sales strategies that you used. How did you go about getting credibility, especially having not really worked in the street, finance? How did you go about demonstrating that you had the expertise and that they should invest in your fund.
OK, this is secret number two. Are you ready? Are you writing down? OK, so, let me tell you secret number two. I’m giving you all my secrets. Secret number two is – when I started the funds I had eight investors. These were eight people who knew me really well. I sat them all down together, I took them to dinner, so again I gave them a flower. I paid for the dinner. And I told them that, listen, you were put on this earth for one reason and one reason alone. And that is to sell the hell out of Pabrai Funds. And the way you are going to sell the hell out of Pabrai Funds is very simple. No commissions and no fees. You get nothing for it. But the reason you are going to do it is because you like me so much. So, and then I asked them, are you going to be salesmen for Pabrai Funds? And they all said absolutely. You know what Bill Gates said right? “You have to ask for the order”. So after a year we went form 8 to 17 investors. Then I sat down with those 17 investors, again I bought them dinner. Again I explained to them why they were put on this earth. What was their meaning of life, why they were here. And again I explained to them. Then a year later we had 25 investors and again I explained the same thing to them. So the thing is it is not really difficult. Actually, if you think about the power of compounding – if you have a million dollars and you compound that at 26% a year, after 30 years you are going to have a billion dollars. Now the 26% a year, part of it can come from growth in your investments, your return on investments, and part of it can come from assets under management growth. So if you are say generating a 15% return – we have a million dollars. In a year you have made $150,000 from your investments. And you only get $100,000 more from an outside investor. You have 25% more than what you had a year ago. And the next year you again add 25%, how difficult is that? I mean, to get a $100,000 after you have a million dollars, after you buy them dinner and tell them why they are on earth, why wouldn’t they do that? And so the thing is, like what Bill Gates said right? Even if you are a monopoly you ask for the order. I just told them “this is what you are supposed to do”. People don’t know what they are supposed to do. You tell them what to do, they go do it. [laughter]
Question: Who got inspired by Warren Buffet and a lot of value investors. Have you made any effort to improve their model to get better results in your own approach?
To be a great cloner, never improve anything. Do not trust what you have is yours you to improve anything at all, OK? [laughter] There are great humans like Steve Jobs who were put on this planet to truly improve it. You don’t need to be Steve Jobs. It’s OK. It’s OK not to be Steve Jobs. There will be enough yo yos who want to be Steve Jobs. Let them be Steve Jobs. Now Warren Buffett for example did improve on the Ben Graham model. Canadian Value Investors . Com Instead of buying cheap businesses, he knew he should buy great businesses at a fair price instead of a fair business at a great price. So he made a change. But it was a change after a long time and more power to him. But the thing is we don’t really need to be like Buffett. Why do we need to be like Buffett? Leave him at the altar. We can homage to him. God bless Buffett. We can just clone. What is the point? Are you trying to make money or are you trying to create a legacy? Keep it simple. There’s very simple ways to make money. Number one rule, shut the brain off. [laughter]
Question: What constitutes understanding the business? How do you distinguish between thinking you understand the business and actually understanding it? How can you distinguish?
Charlie Munger says, to ask the question is to answer it. Did you understand that? [“I think my brain is off”. Laughter] So basically, if you are operating within your circle of confidence you will not need to ask yourself “do I understand the business”. The moment you ask yourself “do I understand the business?” you do not understand the business. So to ask the question is to answer it. If you are asking yourself the question you are operating outside your circle of confidence. Shut your brain off, don’t even ask the question. Just clone the others. [laughter]
Question: [Professor George] Normally I ask the last question. And I suspect I will know what the answer will be but I will ask it anyway. What is the biggest lesson you have learned in life in investing in the last thirty years.
That’s a loaded question. I will have to think about that. There are many things. I would say the best things in life are free. I think that is true. I think the simplest things in life give you the greatest returns and the greatest pleasures. Simplicity, people discount simplicity. I think simplicity is a very powerful trait. Always try to keep it simple. I would say these are some of the basic lessons I would say. And like Munger says, there are many many super smart humans, most of them dead who have lived before us, who have left us incredible amounts of knowledge and wisdom. We just need to pick it up. We don’t need to invent it. We just need to pick it up and I think pretty much any life circumstance that you get into, there’s stuff in the past that will help you deal with it and transcend it. You just have to be willing to find the right things and be a learning machine and pick it up.