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Pabrai on Averaging Down on Investments and Direction of the US Dollar

July 24, 2011

Continuing on with the notes from the 2010 Pabrai AGM. I was very interested to read the comments from Mohnish on averaging down on a position when it falls and his confidence in his ability to predict Chinese growth vs. the US dollar. Here is the Q&A:

Q: Can I return to your selling rule and ask you if there's a corollary, you know I might call it the double down rule. When you buy a stock and then it falls in value significantly, are there times when you go ahead and follow your money with more or do you size your position in the first place such that that's your position and that's where you're going to stay?

A: That's a good question. If you keep doubling down forever on AIG for example, you're done. So there are some limits to what you can double on. The one thing I always look at it is what is the cost basis of your investment relative to the size of your fund. Not the current value of the investment but the cost basis. So I always look at cost basis versus the size of the fund. When I'm ready to pull the trigger, I have decided whether this is a basket bet at two percent or whether this is a full position at five percent. I have clarity. And I've also decided what the intrinsic value is and what the maximum we're willing to pay, etc. And once we've got all those decisions done then we're not going to screw around. We'll start buying at whatever rate the market allows us to buy. And once we've filled our appetite, we're done. So at that point if it drops in half, I'm typically not going to increase position size because that would violate all these other things that I'm trying to do.

Sometimes we can have more assets come in, where what was a five percent position becomes a four percent or three percent position and then it's dropped in half. If I still have faith, we can add to it.

Q: I just wanted to know with all the deficits are you concerned with the value of the US dollar? And if so do you have a strategy around that. And second question, are you busy writing another book?

A: There's no book being written at this point as we have plenty of other fish to fry. The value of the dollar … well you know the thing is I'm not a currency expert. Our assets get priced in dollars. My general sense is that even though there's a lot of talk about inflation, we may see some deflation near term or we may see flat lining near term. There's a decent probability that we'll see inflation longer term and depending on how the other countries do versus us, then we could have drops in the value of the dollar.

That question is not to me as clear-cut as the 100 cities being built, for example. I have much more confidence in the 100 cities being built than in the dollar. And for the drop in the dollar, I couldn't tell you the time frame. Our take on that front is that if I own Teck, for example and it's priced in dollars, that's really not relevant. It's really a set of assets, hard assets and that can be priced in anything. It's really those hard assets that matter.

You can take a look at a company like Coca-Cola for example. Let's say you have Armageddon where the whole planet gets wiped out right. And there's no currency but someone still has the formula of Coke and they can still set up a plant and start producing Coke. So Coke sales go to zero and then someone starts up a Coke factory again. They'll do fine. They might sell loaves of bread for Coke and they'll still do fine.

The issue is not so much that Coke is worth X dollars per share but you need to look at it in a different context. One of the positives about equity ownership versus debt ownership is if you look at the underlying assets, you may be completely agnostic to the dollar.

Q: So I just had a question from a young person trying to build wealth. You can look at the stock market and maybe buy something for ten times cash flow or you can buy smaller companies out in the world for three to five times cash flow and use that cash to buy other businesses. What is your perspective on the best way to build wealth when you can go get 20 percent cash flow yields out there in the market right now?

A: That's heavy lifting. One would have to work for a living. So if you're willing to work for a living then, you know, go for it. But you get into a number of issues about competence and how passionate you are and such about the business. I don't think you should go buy a business because it's cheap. You should go buy a business because you're intensely passionate about it. And you can also start a company which is even cheaper. I'd say it's a question of what you're aptitudes and passions are. And then you pursue it accordingly. The negative of business ownership is that you cannot leverage yourself. So the genius of Buffett and Munger is that they leverage themselves infinitely. They own the businesses but they don't run them. And that's a smart way to go if you enjoy doing that.

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