MI382: Cloning Mohnish Pabrai w/ Shawn O’Malley

24:03Let me just play you some more of that conversation. And so basically what I look for is when I meet somebody, I reflect back after the tea. I say, okay, what do I think and what's going on? The most recent chai with Pabrai I had, that person asked me to come to his place. He lives very close to my home. And he said, I was happy with the Assam tea, but I'm really a fan of Darjeeling tea. And so he says, I make a great cup of Darjeeling tea. And would you come to my home so that we can have Darjeeling tea. And I like the guy. So it's not just one steak, it's more than one. I like the guy. And I said, yeah, so there will be a Darjeeling tea happening, even though I didn't tell him this, but Darjeeling is not my favorite.

24:57But it's okay. If the company is good, we can deal with mediocre tea. And can I go back and then ask, whenever you say that you are a harsh grader and whenever you say you want to be direct, Of course, you also want to be kind, but like, do you literally say it was great meeting you? Or don't you even say it wasn't great meeting you if it wasn't great meeting? And then just saying, well, I've enjoyed these meetings. I'm not lying when I'm telling them I'm not, I've not enjoyed meeting these people because they go through a lot of filtering process before they show up. And I learned from everyone.

25:29So they're wonderful people. But so I'm very direct with them. They were the person who came a few days back and they were interested in going to dinner with my girlfriend and his wife, the four of us together. Now that adds more layers of complexity because she's going to ask me a bunch of questions. Who, what, where, what are we doing here? What's going on? To me, it was obvious. I didn't even ask her. It was obvious to me, that's not going to be in the cards. And so I just told the person, I'm sorry, things are too busy. We can't do it. All the best. And then he had a very gracious response.

26:13So it was fine. I think what you find is that when you're direct with people, it's not like they're sad. I think they appreciate the candor. That was sort of a tangent, but I wanted to make the point that Monish very much blends lessons learned from investing into the way he lives his life. While there's probably a good business case for being selective with your time, for better or worse, Pabrai extends that to his personal relationships too. I have difficulty being as direct with people and protective of my time as Pabrai is, but I can certainly appreciate the approach to life that he takes, especially since in some ways it's molded after Warren Buffett.

26:50Pivoting back toward investing, Pabrai's approach has evolved over time, though I think this description from Forbes sounds about right? They write that he, quote, has no interest in a company that looks 10 % undervalued. He's angling to make five times his money in a few years. If he doesn't think the opportunity is blindingly obvious, he passes. So again, that's a pretty good way to put it. To understand Pabrai and his approach more, I want to turn to William Green's excellent book, Richer, Wiser, Happier, and its full profile of Pabrai. As Green outlines, in 1994, Pabrai had reached$1 million in savings, and as he sat waiting in the airport, he began to read about Warren Buffett and was astonished at how well he had racked up investment returns.

27:31Earning 31 % annually for 44 years up until that point, Buffett would have turned$1 invested with him in 1950 into$144 ,523 by 1994. In awe of both Buffett and the power of compounding, Green explains that Pabrai wondered whether he could mimic Buffett's winning approach and play a 30-year game of trying to turn his$1 million dollars into a billion dollars. Investing, as with so many things in life, is one big game that we can seek to win at. And Pabrai loves to play games, particularly games he knows that he has an advantage in. The question then is, how do you win the game? As Pabrai phrases it, you've got to play according to the rules.

28:11And the good news is I'm playing against players who don't even know the rules. The lesson for all of us here is that rather than trying to devise some complex way of beating the markets, Fabrai instead opted to identify the most skilled players at this game of investing, analyze what had made them so successful, and then mimic their approach with scrupulous detail. Fabrai told Green that he is actually a shameless copycat and that everything in my life is cloned. I have no original ideas, he says. You might say that in some sense, Fabrai is a testament to originality being overrated. On the other hand, though, there's something especially original about his devotion to cloning.

28:48As William Green puts it and Richard Weiser happier, he and Pabrai have spent a lot of time together, from annual visits to Omaha for Berkshire meetings to sharing a bunk bed on an all-night train ride across India. Along the way, he, quote, came to appreciate the tremendous power of Pabrai's method of reverse engineering. Pabrai, the most relentless cloner I've ever encountered, has taken the art of appropriation to such an extreme that, paradoxically, it seems oddly original. Pabrai's approach is as simple as consistently observing the world inside and outside of his industry. And whenever he would see someone doing something that he thought was smart, he forced himself to adopt it in whatever way he could.

29:26And after having studied Buffett and Munger so closely and embracing their outlook so dearly, he was surprised to study other investors and learn that many of them followed completely different sets of guiding rules. Pabrai's conclusion was that most money managers own too many stocks, paid too much money for them, and traded them too often. In his words, Pabrai expressed concerns that mutual funds are sitting there with 200 positions. How can you find 200 companies that will all double? Then I look at what they own and they own things that are trading at 30 times earnings. And I saw that they were all hosed.

29:58There are no prizes for frenetic activity in markets. Instead, investing is mostly a game of waiting for those rare moments when the odds of making money vastly outweigh the odds of losing it, at least in Pabrai's view. As Green continues and his book. This is a skill that Pabrai learned from Buffett, who has been sublimely indifferent to the cries of the crowd and who can idly twiddle his thumbs for many years, such as during the 1970 to 1972 market euphoria, where he felt almost everything was trading at a crazy valuation. When markets naturally returned to earth in 1973, Buffett promptly bought a major stake in the Washington Post company, which he held for four decades.

30:37Pabrai compares the approach to being like a spearman standing next to a stream. Most of the time you're doing nothing until suddenly a fat juicy salmon swims by and then you spring into action to spear it. And then it may be six months again before that next salmon goes by. Contrast that approach with the more typical money manager who takes many small and frequent bets to quote unquote diversify. From Pabrai's perspective, the odds just aren't in your favor enough to rationalize all that activity. In this vein, he's known for saying that the number one skill in investing is patience, specifically extreme patience.

31:10For example, in the 2008 crash, Pobre made 10 investments in short succession over about two months, whereas in more normal times, he bought only three stocks across all of 2012 and none in 2013. Given his supreme patience, you won't be surprised to learn that his favorite quote is from the philosopher Blaise Pascal, who says that all of humanity's problems stem from man's inability to sit quietly in a room alone. Similarly, you might say that Berkshire shareholders have profited hugely from Buffett's inclination toward financial tranquility by distracting himself with playing online bridge, which helps counteract the natural bias for action in investing.

31:48All in all, after first setting out to turn his$1 million into$1 billion, Pobreis surpassed that mark years sooner than expected. After 10Xing his nest egg in less than five years, he had enough friends and family interested in financial help to launch a fund to manage their money. William Green continues to explain that for Pabrai, one of the secrets of successful investing is to avoid anything that's too hard. He automatically passes on investments in countries like Russia and Zimbabwe, given their lack of respect for shareholders' rights. And he avoids all startups and IPOs since they're unlikely to be available for investment at bargain prices.

32:25Relatedly, he's never shorted a stock because the maximum possible return is 100 % if the stock falls to zero, whereas the losses have no cap if the stock keeps rising and rising. And that's not the sort of risk return profile he finds attractive. In short, simplicity rules for Pabrai. When asked by Green why more people don't embrace his systematic method for cloning, he told him, quote, they're not as shameless as me. They have more ego. To be a great cloner, you have to check your ego at the door. Let's take a quick break and hear from today's sponsors. Hey, it's Sean O'Malley, just popping in with a quick message.

33:01If you like this podcast, well, I've got great news for you. We've got a handful of other shows for you to explore, from learning about Bitcoin to embracing a richer, wiser, happier lifestyle. Just go into your podcast app and type in We Study Billionaires to find our collection of shows. We Study Billionaires is our flagship podcast, and we've made a name for ourselves over the years by interviewing the best investors in the world, including Ray Dalio, Howard Marks, Joel Greenblatt, and many, many more. My colleagues Stig Brodersen, Clay Fink, Kyle Greve, Preston Pysh, and William Green each host their own We Study Billionaires episodes and bring their own unique perspectives.

33:38A whole new world of insights awaits you. Just go ahead and type in We Study Billionaires into your podcast app and see what you've been missing out on. Seriously, go ahead. I promise you'll like what you find. Bonus points if you show your support for our work by clicking follow. If something piques your interest, just start listening. No hard feelings. I'll be waiting for you back here. Just like everybody else, there was a time when I was a beginner investor, and I have to say, investing is particularly filled with jargon that can just make it so difficult for new investors to understand what is going on.

34:08But it's never too late to get smarter about stock investing from the ground up. At The Investor's Podcast Network, we've made a habit of studying the world's best investors, and now I'm distilling those learnings into a simple course for you or for anyone in your life who you might want to share the gift of knowledge with. With my How to Get Started with Stocks course, you can master the principles of excellent lifelong investing with valuable insights for both beginners and pros. The course covers 10 different sections, beginning with the basics of what a stock actually is and how the stock markets work, to strategies to optimize your retirement savings, how to pick great companies for the long term, what to look for in ETFs, and how to monitor your investments, plus so much more.

34:47To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. Not to be cliche, but building a market-beating portfolio really doesn't have to be a mystery, at least with the right tools. If you've listened to our podcast for a while, then you know we spend a lot of time learning from savvy investors. So why not use the same tools we do? With TIP Finance, you can. Screening for great companies, calculating intrinsic value, keeping up with legendary investors' portfolios, and more are all not just possible, but easy to do.

35:33TIP Finance was created by investors for investors. It's quite literally the tools we wanted to use ourselves when researching investments in a simple to use interface. You can get started by creating an account for free. Who knows, maybe TIP Finance will help you find your next 100 to 1 investment. Between the screener and Legend Investment Portfolios to reference, I've gotten a ton of ideas from TIP Finance. What are you waiting for? Take the next step in your investment journey today with the right tools at your fingertips. Grab your device and type into your browser, theinvestorspodcast.com slash tip-finance to get started.

36:12That's theinvestorspodcast.com slash tip-finance. All right, back to the show. So those are the highlights from William Green's delightful book, Richer Wise Are Happier, and the profile specifically on Manish Pabrai. I would of course recommend that you read the whole thing for yourself, but hopefully that helps paint a more complete picture of who Pabrai is. As we continue on and learning from the master cloner, I want to turn to his 2019 lecture to students from Peking University. It's about an hour and a half long and an absolute joy to listen to because Pabrai, again, is such a gifted storyteller.

36:48He shares with the students that while it's tempting to think otherwise, not every great business is a great investment. That is not to say you won't earn a decent rate of return by investing in great businesses, which is something we've talked a lot about in recent episodes. But at least with mega caps, the room for upside isn't enough for those investments to generate these sort of outsized performance that's going to enable you to compound your wealth at more than 20 or 30 % per year. If as a game, investing was simply about investing in the companies with the best business models, it would be an easy game to play.

37:19But it's not so simple because almost everyone else will see high quality businesses for what they are too. With a massive payments company like MasterCard, that is an incredible business, high barriers to entry, oligopoly, and high returns on invested capital. But of course, it trades at a price earnings ratio of 40, which is more than twice the historic market average. So not only is the company already very large, limiting its ability to massively grow its market value, but also investors are already paying a rich price for that quality. Part of what distinguishes Pabrai is that he has such ambitious goals for his investment returns.

37:52He's not happy with simply beating the market by a few percentage points over time. He wants to absolutely crush it. And to do that, you have to be extremely aggressive. And while we talked earlier about how a single high-quality investment held for long enough, like holding Walmart since the 70s, can be a game changer. The wrinkle here is that buying into Walmart then was when the company was still at an early stage in its life cycle. From October 1984 through 2000, Walmart increased its market value by 30X. For Walmart to do that again from 2024 through 2040, its market capitalization would be over$19.5 trillion, which is roughly the size of China's entire economy today.

38:30Okay. So obviously you just can't expect Walmart to be a 30 bagger at this point in its life cycle, which is okay. And shareholders may continue to do quite well with it, but it's not going to have the massive outperformance that it once did either. Even though Walmart continues to have an incredible business, it's not as simple as recognizing that and buying the company's stock and then becoming vastly wealthy. This is a conversation Pabrai tells the Peking University students that he's had at length with his friend Guy Spear, who happens to love owning high quality blue chip companies like MasterCard.

39:01After Guy had already made a 12X return on MasterCard, Pabrai sought to convince him that he wouldn't be able to earn those same returns again with the company due to its size, so he should sell and look for opportunities with bigger payoffs. While MasterCard was and is still a great company, Pabrai doesn't think it's a great investment. On the other hand, with the small Indian company Suntech Realty, he doesn't think it's that great of a business yet, but he loves it as an investment. That is to say, good companies can make for great investments and great companies may only make for good investments.

39:31With that idea in mind, he challenged Guy to a bet in 2018 to see which stock would do the best over the next 12 years through 2030. The case for Suntech Realty is that it's a property developer in Mumbai. And after getting to know the management of the company, not only does Pabrai think they have a great grasp on capital allocation, but he knows they have this long-term tailwind that other investors may not be patient enough to wait for. And that tailwind comes from the fact that over the next few decades, as India continues to industrialize, Mumbai is going to get torn down and rebuilt in the same way that happened in many Chinese cities as they modernized.

40:05And as Mumbai gets redeveloped and grows into one of the biggest cities in the world, if not the biggest, then Suntech will be a major beneficiary of that. But in the meantime, there's this cloud of uncertainty hanging over whether this will really happen and on what timeline. And that makes for a great opportunity in a company that, at least based on its track record isn't clearly exceptional in the same way that MasterCard is. Yet, Pabrai argues, as investors, it's our duty to peel back the onion. Behind the facade of an obscure, historically average real estate company in Mumbai, he sees a company that's poised to grow explosively in the coming years, boosted by India's inevitable advance and a sound management team.

40:43Pabrai is more than happy to hold SunTech for a decade or longer and see if that comes to fruition. Funny enough, around halfway through that bet with Guy Spear, it actually seems that Guy is winning with MasterCard up around 90 % in the past five years, whereas Suntech is up about half as much at 48%. And that 48 % is for the price in rupees, which is depreciated by 18 % against US dollar in the past few years. So Suntech's performance in US dollar terms is actually lower, but still we will see who ultimately wins in a few years. And I think Pugrai's point remains regardless of whether he wins the bet.

41:16Great companies, especially if they reach a certain size are not necessarily great investments. And more average companies with undervalued shares or a large runway for growth can in fact be great investments. I'd add to this to say that market prices for stocks are fundamentally about expectations since companies are valued based on the earnings they will create in the future. The challenge with investing in large, well-known, great businesses is that expectations are going to be high. Great companies have high expectations for their performance. And if they do stumble, they'll pay dearly for it, as famously happened to Coca-Cola when it experimented with changing its signature formula for its drinks called New Coke.

41:54That did not go over well, to say the least. But if you can find a company that the market thinks is just good, but actually has hidden moats that make it a great business, like Pobride thinks is the case with Suntech, then you can benefit from not only owning a company that can compound returns at high rates, but you'll also have the tailwind of the price to earnings ratio rising in your favor as the market eventually realizes how good the company is. There are over 50 ,000 stocks that trade publicly around the world, and by Pabrai's estimate, around 3 ,000 of them are severely undervalued. While he probably can't understand most of those 3 ,000 companies, all he needs to do is to be able to understand three or four of them well enough, and he thinks he'll do just fine.

42:33My takeaway is that to beat the market, you need to look where the market isn't looking. While MasterCard probably has 30 different analysts tracking it on Wall Street, some smaller and more obscure company may be structurally underfollowed, which makes its pricing less efficient and creates more opportunities to buy in at a discounted valuation. Either way, though, I really like how Pugai tells the Peking University students that you'll only ever completely understand a business once you own it. And I think that's so true. When you have skin in the game, there's just a different mindset subconsciously.

43:03You have more reason to care about whether you actually understand the details behind the business in a way that's not really possible when you only own it on paper. In my personal investing, I've taken a similar approach where I'll sometimes begin with a small position in something, and that will either drive me to become more interested and dive more deeply in understanding it, or I'll lose interest and just drop it. I don't do it all that often, but when I do, it's when I'm on the fence about the opportunity and I want to give myself a little extra boost to look at it more seriously. And once I have money on the line, even if it's a very small amount, it's much easier for me to get excited about digging into the weeds of it.

43:38I would be remiss to talk about Pabrai today without at least touching on his wonderful book, The Dundo Investor. The natural question here, obviously, is what is Dundo? As Pabrai defines it, Dundo is a Gujarati word. Dan comes from the Sanskrit word dana, meaning wealth. Dondo, literally translated, means endeavors that create wealth. The street translation of Dundo is simply business. And what is business if not an endeavor to create wealth? More tangibly speaking, you might say that to make Dundo investments is to find nearly risk-free bets with massive upside, the classic heads I win, tails I don't lose much type of investment.

44:17To show Dundo in action, Pabrai recounts the story of the Patels, an Indian family that in just over 30 years owned over half of the motels in America. With no money and little formal education, the Patels immigrated to Southern California in the 1970s and began doing blue collar work in the motel business. At the same time, the US was entering a deep recession and gas prices were astronomically high, so many families were skipping vacations to cut costs. Hotel and motel occupancy rates fell very low, and as banks foreclosed on properties, a number of motels went to market in distress at fire sale prices.

44:52Seeing the opportunity to buy these assets from motivated sellers, Papa Patel realized they could purchase a motel business with 80 % or 90 % bank financing. Even better is that he could house his entire family in the motel for free while they worked to run the business. And if the business flopped, Papa Patel knew that he and his wife could always go back to working overtime to save up enough money and just try again. This was a classic dundo bet with a low risk and a very high reward. With just a few thousand dollar down payment, the Patels bought the motel and saved on all their expenses since they didn't need to hire anyone outside of the family.

45:27That combined with their frugal lifestyle enabled the motels to become quickly profitable. As you can imagine, the Patels never lost their work ethic or caution and oversaw a disciplined expansion across the country as they snapped up everything from hotels to gas stations, convenience stores, and even luxury hotels. The Patels were a low-cost producer and they undercut competitors with prices that more commercial operations could hardly fathom charging. Work ethic, business savviness, and a bias toward dramatic action when the odds are massively in your favor is the epitome of Dundo. Pabrai's own Dundo story came from launching TransTech, a software business when he was 25 years old with just$30 ,000 in retirement savings and$70 ,000 in max credit card limits that he could tap into as needed.

46:11Pabrai dug into bankruptcy law in the US and realized that if his business fails, he could just declare bankruptcy and essentially start from scratch again. So he felt like he didn't have much to lose, while the upside was that he could become independently wealthy. While Pabrai worked his job during the day, before and afterwards, he worked on building his company and put his paycheck toward overhead expenses. Once his startup reached$200 ,000 per year in revenue, he quit his day job. The worst case in his view was that he might lose$30 ,000 in savings in a job he didn't really care about, but that was all since he had no wife or family to support.

46:45In the best case scenario, the idea might make him a millionaire, which it did. Pabrai's model for making dundo bets distills down to investing in simple existing businesses where there's low risk but high uncertainty. For example, with the motels, they were low risk in that the Patels personally had little to lose, but also because motels were not likely to be phased out of existence. There was just a recession that created a cloud of uncertainty over the business, which if anything, created an opportunity for patient investors like the Patels. Even better, if you can snap up distressed assets where the seller is being forced to sell because of a bank foreclosing on them.

47:19To be Dundo is to always have an eye open for Dundo investment opportunities and betting heavily when the upside significantly outweighs the downside. In his own way, Papa Patel was a cloner like Pabrai. Rather than try and launch the next hot tech company and create some disruptive innovation, Papa Patel embraced a business model that he knew was proven to work, did so at distressed prices, and then built a low-cost moat by being able to profitably afford rates that none of his competitors could. While no one knew when the recession would end that was hurting motel businesses, Papa Patel knew it was a question of when, not if, and that uncertainty gave him the cover to buy and build a business at a cost that he would otherwise never be able to do so at.

48:01The example with the Patels really resonates with me because I know I personally spend a lot of time looking at businesses to own in public markets when there are probably so many wonderful privately owned businesses that I could acquire and operate myself or hire someone else to operate. I also appreciate the personal elements being factored into Dundo risk-taking here. As in, Pabrai felt he had nothing to lose with TransTech because he was young, didn't have that much money, and had no one depending on him. So of course he could afford to take what looks like a big risk because it wasn't really that big of a risk.

48:30Same with the Patels. While Papa Patel did have dependents, they were already very poor and they were accustomed to living that way. So losing all their savings in a failed motel business wasn't really as big of a risk as it might seem on paper. But obviously the upside has been higher than I'm sure they could have ever dreamed. A Dundo mindset, in my opinion, is about not only pursuing high reward bets, but also bringing a financial and personal perspective to your risk tolerance. If the Patels lived stable, middle-class lives, they probably wouldn't have jumped on the opportunity to buy a motel business.

49:02And if Pabrai had a wife and kids, depending on him, he might have just kept his day job. It's not that you can't chase big opportunities if you have a family, it's just that you have more at stake and that needs to be factored into your risk-reward calculations. The Dundo Investor is a pretty easy to read book, but it touches on the nuances of risk and reward in a way that few other books capture. With that said, I want to begin wrapping up today's episode. Manish Pabrai is a uniquely eccentric, independent thinker devoted to being as pragmatic as possible. His common sense approach to investing takes cloning to the extreme, yet that cloning has worked out wonderfully for him and enabled him to build relationships with the very people he cloned, like Warren Buffett and Charlie Munger.

49:42Pabrai is one of my favorite investors to listen to because he really does tell the best stories. Someone who has spent so much time hanging out with Charlie Munger naturally has some interesting things to say. We haven't really touched on it today, but what's also great about Pabrai is not only his devotion to teaching others, but also his devotion to charitable work. His charity in India is called Dakshana and has changed many lives for the better. If you're curious to learn more about it, I'll link to it in the show notes. Pabrai reminds me that investing is a game and to win at it, we should learn as much as possible from the best players of that game.

50:13And after spending many years carefully studying others, he too became one of the best players at the game of investing, who ironically I am now studying. He also reminds me that investing should be fun. As I said, it's a game and one we choose to play. If picking individual stocks is stressful or overwhelming for you, then don't do it. Just go buy an index fund. Pabrai and others like him get immense joy from trying to stack the odds in their favor and win more than anyone else in investing. and that's why he'd be happy to do it even if it wasn't for money. Whether it's in investing or something else, Pabrai's most important lesson for us all is to go and find that thing we're so passionate about, we'd continue doing it even if we won the lottery tomorrow because again, it's not about the money.

50:56To put a bow on this conversation about Monish Pabrai today, let me leave you with one of my favorite quotes from him. He says the following, you don't make money when you buy stocks and you don't make money when you sell stocks, make money by waiting. That's all for today, folks. I hope you have the patience to embrace your interdundo investor. I'll see you again next week. Thank you for listening to TIP. Make sure to follow Millennial Investing on your favorite podcast app and never miss out on our episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only.

51:32Before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.