Holly: Hi, welcome to the GuruFocus podcast, I'm Holly. I'm the editor of GuruFocus, and I’m here with a very special guest today. It's Mohnish Pabrai (Trades, Portfolio). He is the founder of Pabrai Investment Funds and the Dhandho Funds, and he's also the author of a book called “The Dhandho Investor: The Low-Risk Value Method to High Returns.” So Mohnish is a very highly regarded and well-known investor. We're very excited to speak with him today. So he has achieved outstanding -- definitely beaten the market, by far. Another interesting thing: He was lured into value investing by reading Warren Buffett (Trades, Portfolio) and Peter Lynch. And his ideas are also widely followed in the world of value investing. So welcome, Mohnish, how are you?
Mohnish: Well, Holly, I've been a fan of GuruFocus for a long time, so great to be here.
Holly: That's great to hear. Thank you so much. You have many investing ideas I wanted to get to, but I wanted to start with what a lot of people are talking about right now, which is that you’ve moved from the U.S. to India, mostly. So most of your portfolio is in that area. But I'm interested to know, with the U.S. market being so high, you said you were having trouble finding good quality, low-price companies. But I looked at the Indian stock market, and I thought it must be very low. But it's not, it's at all-time highs, as well. So what made you then interested in that market?
Mohnish: Yeah, so actually, India is not a cheap market. In fact, I would say India is an expensive market. But it also has a very large number of listed companies, close to 5,000. And a common theme across these companies is that, in general, Indian promoters and management teams do quite a poor job of explaining their businesses. And as a result of that, there's a lot of misunderstanding, in terms of where these businesses are going long term, in the future. So it actually lends itself to being a good stock picker's market. I think most Indian stocks are overvalued, so there's no point going through them. But in a small sliver of cases, where there was distress overall in a particular sector, and business models that were not understood well by the investing public, led to a kind of wide gap between price and value.
So to give you one example, which I think is one of our larger holdings in India, is a company called Rain Industries (BOM:500339, Financial), and we had made that investment in 2015. And I actually had received -- someone had cold-emailed a research report. I didn't know this person, but it was a very well-written report that someone had sent me. And very soon after reading that, it was obvious that there was very good business available very cheap. Basically, I was buying, in effect, Rain Industries at a P/E of 1 on possibly earnings that might come in in two to four years.
And so if you're investing in 2015 in a $200 million market cap, and by 2018 or 2019 its earnings are $200 million, generally good things are going to happen to you. And that actually did come to pass, and the stock went up, I don't know, 12 times. And it has since pulled back quite a bit, but I think it's still a double or triple for us so far. So there are sectors.
So, for example, in late 2016, India went through something known as demonetization, and then it actually came up with some rules: RERA, the Real Estate Regulation Act, and also GST, the Goods and Services Tax. So a combination of these three windfalls, it took out 80, 90% of developers from the market. They basically went out of business. And the high-quality players left standing saw significant hits to their stock prices, and those became great investments. So we made a few investments in that space. And so basically, I think, India, you have to kick the tires. You have to kind of drill down. But I think that there are lots of inefficiencies in the Indian market, if one is willing to drill down.
I haven't given up on the U.S., I was just having a hard time finding businesses. But we did actually -- came out in our 13F, we did find one business that we invested in. Now, we won't go into why we invested in it. But we own Micron Technologies (MU, Financial), which is in the memory business, and so we do have one recent U.S. investment we’ve made.
Holly: Yes, I did notice Micron. Can you talk about how you found that company, or anything?
Mohnish: So I subscribe to Value Line, which is a good publication. And I think for 12 or 14 weeks in a row, Micron showed up as either the lowest P/E, or amongst the top three lowest P/E stocks in the entire Value Line 1,700-stock universe. Usually I always look at the low P/Es, because sometimes I can find things from that list. But usually the companies that have the lowest P/Es are the ones you don't want to touch with a 10-foot pole, because they’re there for a reason. But sometimes there can be anomalies.
So I noticed this very low P/E, and then a fund manager friend of mine mentioned that he owned the stock. And so I said, “Okay, this person isn't exactly an idiot, so why don't I drill down and just see what's going on with Micron?” And when I drilled down, I decided it was worth taking a position. But beyond that, I don't want to talk about it at this point. We'll discuss it at some point when we don't own it.
Holly: Yes, okay. Yeah, I thought we couldn't touch on the companies that you just bought, but what you did say was - thank you for that - interesting. So when the market did pull back in the fourth quarter, did you find more mispricings in India or in the U.S., or did that create any more opportunity?
Mohnish: I think the only thing we found in the U.S. at that time was Micron. I think India, yeah, things became a little more interesting. So we were able to move to, I would say, higher-quality names at better prices, which was good. I also made two trips recently, and these were kind of unusual for me. They were fun trips. One was to Istanbul in Turkey after the Turkish lira collapsed, and the second was recently, to South Korea, Seoul. And so basically I was just curious about meeting a few companies, and looking at the businesses. So we did make a couple of investments in Turkey, which we are quite excited about. But again, I think they'll go nameless for now. And we are in the process of buying one business in South Korea. So these were kind of unusual in the sense that I saw very cheap markets, which is not the case in India. And I didn't have a plan that we would invest or not invest. I just said, “Okay, let's go kick the tires.”
So South Korea is interesting because the KOSPI, which is their index, 30 years ago, used to be at about a level of 1,000, and now it's at a level of about 2,000. So in 30 years, it has doubled, which means that it's gone up approximately 2 or 2.5% a year. And in the last 30 years, the Korean economy has been on fire. I mean, really, the civilization got developed in the last three decades. So on many fronts, Korea is quite a cheap market. And so I said, “Okay, we have a cheap market, we have some very high-quality businesses. Let's just see if there's something we can get our arms around.” And so both the Turkey and South Korea trips were kind of unusual for me. But they were fun, and they actually, I think, have been quite profitable.
Holly: That is very interesting. I didn't know that. So when you were there, did you go over there to meet with managements? And if people are interested in these countries that you're looking at, is meeting with management something that's really important that you do? Or do you think you can invest without being able to fly over there?
Mohnish: Yeah, so I don't think one can invest in India or Korea or Turkey without meeting management. And in the U.S., for example, I almost never meet managements. I mean, if I look at our Micron investment, I've never interacted with anyone at Micron. But I think that, yeah, absolutely. I would say these three countries, you have to have a very good idea of the -- well, the first thing, you want to make sure you're dealing with honest people, with high integrity. That's the first baseline. And then we get into other things where, are they competent, and do they understand capital allocation, and all those sorts of things, and quality of business, and so on, so we can evaluate all that.
Holly: So besides that, I know that you have a famous checklist that has 100 or so things that you want to know about a company before you invest. So whenever you're going abroad, do you change that? Does anything move up to the top that maybe you wouldn't think of in the U.S., or that becomes more important?
Mohnish: No, the checklist hasn't gone through any changes recently. Occasionally questions get added. I think it has close to 160 questions on it. It's a pretty comprehensive list. Basically, whenever I'm looking at a business, before investing I'll just go through, and usually the checklist will highlight a few areas where I actually don't know the answer. Which is what I would say the biggest advantage of the checklist is. It forces you to make sure you've actually gotten all the data.
Holly: So when you’re investing in India -- well, I just started looking into it, and then I saw that JPMorgan and Goldman Sachs were also saying that they were very bullish on India now. So it seems like they're catching up with you, to see that this is a great growth market. But what was it about the market that appealed to you? Was it just the number of stocks there, or was there something else? They were touting the earnings that are supposed to be growing faster, going forward. Was that appealing to you on a macro level, or are you only looking at the companies? And also, do you think that because of these big, great macro factors, that buying an Indian ETF would be good enough for an investor?
Mohnish: Well, I think it's not a good idea to make investments based on macro anything. I think one should try to figure out a given business and the future prospects of that business. And one of the things that happens in a place like India is that, if it continues to grow at seven-odd percent a year for quite a while, maybe a few decades, or maybe a decade or two, at least, then there will be quite a significant amount of wealth created, and increase in the standard of living of people. So many, many businesses will grow in scale a lot faster than they would in the U.S. But I think that the way I look at it is that I can understand kind of the macro tailwinds at a high level. But what I am really focused on is individual businesses, because what -- the micro will trump the macro.
So you can do really poorly with great macro tailwinds, with management teams that aren't that great, or businesses that aren't that great, or people with ethics that are questionable. So I think what you have to do is you have to make sure that you've tied up with very high-quality people, you've got a business which has got tremendous tailwinds, and you've got jockeys running those businesses that are world class. And you are getting in at favorable prices. So that's generally how we look at it. I would not recommend just blindly going to a country with an ETF, et cetera.
Holly: Okay, I see. So when you're looking at companies -- I noticed that you said recently you are moving into more high-quality companies, and you want to be unreasonable, in that you're asking for very low valuations on some very high-quality companies. So how would you define a high-quality company? What's your definition?
Mohnish: Well, I think the first is that you've got to have an enduring moat, and some kind of sustainable advantage which gives the business an ability to earn high returns on capital for a sustained period. The second, which will probably be tied into the first, is the quality of the leaders, and the people in the company. And then the third piece is, what are you paying for that?
Holly: And you said you like, as you mentioned, very low P/E stocks, like a P/E of 1. And then you also mentioned that a P/E of 1 stock is P/E of 1 for a reason, usually, and that you only find these stocks every couple of years. So how do you know that that one P/E of 1 stock is the one that is worth investing in, and isn't that way for a reason?
Mohnish: So globally, we have something like 50,000 stocks. And these are traded in auction-driven markets, which are controlled by humans. And any time you have auction-driven markets, you're going to have wide ranges of pricing of a number of securities. And especially when you look at businesses which have traits, like let's say high uncertainty, but low risk, generally speaking, markets will have a difficult time pricing those businesses appropriately. They may get under-priced. And so we're looking for a scenario where there are, let's say, temporary headwinds, which the market doesn't like, and taken the stock out back and chopped it, if you will. And if you can see through that, where sometimes the market's very focused on the next six months, and if you are focused on the next three to five years, you will gain an advantage, because you're willing to accept that a business may not do well for six months. Which is fine. And so I think what you're looking for is -- I would say most stocks that are cheap are cheap for a good reason. And they may not be good investments. But there are always a sliver of stocks which are cheap for illogical reasons.
And so the good thing about this business is that it can tolerate a healthy error rate. So even if you look at Warren Buffett (Trades, Portfolio), Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), I mean, they've bought 80 or 90 businesses over the last several decades. Probably at least a third, or maybe close to 40% of the businesses they acquired have ended up not being great. Now, they've been right, or they’ve been able to fix the ones that were the big ones. So if you look at it from a dollar perspective, something like maybe 80% of the dollars they invested have done really well. But if you equal weight every decision, maybe 40% have not done well. And even then, Berkshire Hathaway has a great record.
So this is a business where we can be wrong three out of 10 times, or even four out of 10 times, and still come out with an exceptional record.
Holly: Right. And you've mentioned that you're a quote-unquote shameless cloner. And whenever you're making your checklist, that you observed the common errors that other investors would make. And so whenever you were doing that, and studying these people, what did you find that was the number one place that other investors went wrong?
Mohnish: Well, the number one place where I have gone wrong, as well as where other investors have gone wrong, is leverage. So what I notice -- the way I've built my checklist is, I only put items on the checklist where some great investor had made a mistake, where that mistake was obvious before the investment was made. And so let's say, for example, if you look at Berkshire Hathaway, the textile mills, or if you look at Dexter Shoes that they bought, I mean, both got decimated by cheap foreign labor. It should have been -- if you had really thought about that before the investments were made, the data was already there.
So what I'm trying to say is that the No. 1 area where the maximum number of problems have come up for most investors has been leverage. And it has been a problem for me, as well. If I look back over the last 25 years, I would say the biggest area where I have lost money has been leveraged institutions. And so what I have learned is to be very careful when going down that path. In fact, the best businesses are the ones that can make a lot of money with no leverage. And so leverage has been a problem for me, and has been a problem for most investors.
Holly: I see. So I wanted to shift gears a little bit, and ask you -- I was intrigued when reading about your background, how you were formally an engineer, and then a business owner, and then you got into investing and you did amazing. So what do you think -- within 10 years, you were already just trouncing the S&P. What do you think made the difference between you and someone else who also comes across Buffett's letters and becomes an investor? How did you do that? What do you think was the key?
Mohnish: Well, I think Buffett has a quote, he says, "I'm a better investor because I'm a businessman, and I'm a better businessman because I'm an investor." So the skill set I gained as an entrepreneur, and probably even more important, that I had the skill set I gained watching my dad run businesses as a teenager, are invaluable. In fact, I don't think I'd be able to do what I'm doing without those experiences. So it is an advantage to me that I did not go to business school. And it is a very significant advantage that I run a business.
And I think Buffett has another quote. He says, "You can talk to a fish for a thousand years about what it is like to walk on land, but it doesn't compare to one day actually walking on land." And it's the same as one day of running a business, versus two years in business school. So meeting payroll, managing people, leadership, all the different nuances, getting decimated by competition, et cetera. Having firsthand experience of those gives you a very significant advantage. But I don't even know how people who have not run businesses before can become good investors. I think they're missing a huge part of the equation.
So that is a big advantage. I think being an engineer, probably also an advantage, [indistinct] directly. I just think you have a certain -- I have a certain engineering way of looking at things. And I think one of the things, as an engineer, is that I feel that it’s -- if I want to learn something, I can put my mind to it, and learn it and such. But I think the experience of running a business, and I think more importantly, the experience I had during my teen years watching my dad run a number of businesses, was priceless.
Holly: I see. So everyone should start a business, and run it, and be successful, and sell it before they get into investing. It would probably help.
Mohnish: Yeah, you will get a big advantage by doing that.
Holly: Okay, nice. So you also had an advantage, you started in '99, when the market was down. Well, also a disadvantage, because the companies were all cratering. But brick-and-mortar firms were down, like Berkshire Hathaway, and they were cheap. And you actually beat the market by more than 30% when the world was falling apart. And so now, when the markets are so high, is this a good time to get started in value investing? Or somebody who's just starting out, what should they do?
Mohnish: Well, I think if anyone is starting out, any time is good. I mean, I will just say that -- just to put it in context, when I was starting out in '99, it was actually a bad time. And the reason it was a bad time is the Dow had gone from 800 to 12,000 in the previous 17 years. And, in fact, I knew at that time that the indexes, going forward, are not going to do much, just because things were so overvalued. I mean, we had GE (GE, Financial) at 40 times earnings, and Coke (KO, Financial) at 40, 45 times earnings, and so on. So in the '99, early 2000 timeframe, blue chips – Microsoft (MSFT, Financial) at 40, 50 times earnings, et cetera -- were over-priced. All the dot-coms were overpriced. And there were, I would say, some slivers of the market which had a lot of value. In fact, the day the Nasdaq peaked, I think March 6th, 2000, was the day that Berkshire hit a 52-week low. It went to 40,000 or something.
So the thing is, clearly there were areas in the market one could operate in where there was value. In fact, you could literally see money being pulled from Berkshire and being put into Pets.com [laughter] at that time. That's what people wanted to do at that time. And the Barron’s cover would say Warren had lost it. That sort of thing was going on then.
So if you're starting out, modest amount of capital -- any time you start out, there are going to be opportunities if you're willing to dig and look. And even in this environment, which I'm in today, in 2019, yeah, I can't find much in the U.S. But I have adapted the game. So I've adapted it to digging into businesses in India. I think, in the last couple of years, I've met more than 200 companies in India. I've adapted to making a trip to Istanbul, making a trip to Korea. I never did this before.
I think in a world with 50,000 equities, there are always going to be mispriced and under-priced businesses. And our jobs, as investors, is to be on a treasure hunt. That's the job description.
Holly: So if you had to be somewhere in the U.S. right now, you couldn't go anywhere else, where would you want to be? Or would anything look intriguing to you?
Mohnish: Well, I think if I were focused on the U.S., then basically, again, I would dig into businesses. And I think sometimes what you can get is -- I mean, if I look at a business like Micron, I think the market cap is over $40 billion. Any time you look at a business with over $40 billion market cap, there are a lot of analysts covering the company, and there should not be, typically, mispricing. But I was able to find mispricing, even in a large business like that. So I think if one can study many, many businesses, and get conviction on a viewpoint, which is different than what the consensus view is, you may be able to find opportunity. So I think that it's a matter of going deep, and understanding, because, again, if you're only limited to the U.S., if you build up a portfolio of five or seven stocks, yeah. It should be possible to find five or seven undervalued stocks in this market, no problem.
Holly: Okay. I know you don't want to talk about your current position, so I won't. But what do you think about the auto industry in general, as far as the transformation to green energy and the Green New Deal, and competition like Tesla (TSLA, Financial), electric cars? Do you think those pose any threat to the industry?
Mohnish: I hate the auto business. I have always hated the auto business. It's a terrible business, where you're unionized, you're subject to people's tastes, you've got to make multi-billion dollar bets, and then those bets may not work out. So there's a lot to hate about the business.
And when we first invested in Fiat Chrysler (FCAU, Financial) in 2012, the market cap was about five billion, and they were doing about $130 billion in revenue. It was very cheap, from a price to sales perspective. And within that five billion market cap was Ferrari, which has now got a market cap approaching $30 billion. And also, within that market cap was an obscure parts company, Magneti Marelli, which they sold for about $7 billion. So there were a number of things embedded in that $5 billion. So if you had just held from 2012 to today, basically you would have made about maybe seven, eight times your money on Fiat Chrysler, this crappy company in a crappy industry.
And I think that they still have some juice left. They have re-architected the business quite significantly. They don't make sedans, they're heavily into trucks and SUVs. Trucks in the U.S. is a protected market where the top three dominate and there’s a 25% import tax, and they have huge margins. So I think that it's a business that produces a lot of free cash. And in spite of my hatred for the business, we continue to be shareholders.
So moving onto your Free Lunch portfolio. If listeners want to read about that, it's on Forbes, he has articles about it. We won't take up too much time explaining it. But there are three components: the Uber cannibals, who are buying back shares, shameless cloning, which are consensus picks of investors that you chose, and spin-offs. And in a backtest, it has beat the S&P 500 easily, but it's down a little bit this year. So I was wondering, what inspired you to want to make this portfolio and put it out there?
Mohnish: Yeah, I think in 2019, so far, we are ahead of the S&P. I think we're 20-odd percent, versus -- I think the S&P is at about 12 and change. But it's a short period, you know, it's only less than three months.
Holly: Sorry, I meant 2018. Yeah [crosstalk].
Mohnish: So I think the thing is that -- the freelance portfolio, you're better off just looking long term. Even in our backtest, we under-performed for several years, in fact. So in all investing, basically, you’ve got to have a multi-year time horizon. But basically, the idea was that these -- it's a multi-strategy portfolio. It takes the highest conviction, cloned ideas from a few investors. It's looking at some spinoffs, and it's looking at the cannibals. All are good strategies, and we blended it into one. And many times, one particular strategy is doing well, or a few stocks are doing well, [indistinct] so they kind of offset them. But I think over the long haul, there’s a decent chance you do better than the index.
Holly: Great. And in the shameless cloner's portfolio, you have firms that you’ve picked out, like Appaloosa, Cedar Rock Capital, FPA, their highest conviction picks. I didn't see Warren Buffett (Trades, Portfolio) in there, though. Where is he?
Mohnish: Well, the reason we didn't pick Buffett is because his circle of investments is so small now, because he has to deploy so much capital. And so if Warren Buffett (Trades, Portfolio) were managing $100 million dollars, or a$1dollars, he would definitely be in there.
Holly: Oh, okay, that makes sense. Right. So what do you think, which one of these portfolios do you think is going to do the best over time?
Mohnish: I actually don't know. That's why we picked them all.
Holly: Okay, [laughter] so the combination together is giving you a little bit of diversity?
Holly: Okay, I see.
Mohnish: Well, I think the freelance portfolio was kind of a fun exercise we went through. And we have a fund internally that is not exactly like the freelance portfolio, but it's similar, and it's a good alternative for people looking at something that may do better than the S&P and such.
Holly: I see. Okay, so we promised to get to some reader questions, so I will end with that. We had so many, whenever we announced that we were going to talk to you. So I tried to chisel it down to just a couple of the best ones. So the first one is, what is one mental bias that you still struggle with, and how do you overcome it?
Mohnish: Well, I think the mental bias I have is that I still get attracted to levered companies. And I think now with the checklist and the quarter century of history, I'll have to take a step back. And so sometimes I'll get interested, looking at something, and then I'll have to kind of do a double take, and say, “Wait a minute, these are your inherent biases that get you into trouble.”
Holly: I see. So our next one is, from your understanding of Charlie Munger (Trades, Portfolio) and Warren Buffett (Trades, Portfolio)'s investment philosophy, what would you say is the maximum limit one should be ready to pay for shares of a wonderful business? Or in other words, up to what percentage of your estimated intrinsic value would you be ready to pay to purchase shares of a wonderful business?
Mohnish: Well, I think that one should be willing to pay even full intrinsic value for a wonderful business. I mean, the ideal business to invest in is one that is going to grow its intrinsic value significantly over time. And if a business has the ability to grow its intrinsic value significantly over time -- I mean, there are companies that increase their value over 10 or 15 years by 100x, or 500x. And so to some extent, if you have a high degree of confidence of that coming to pass, certainly it would be a mistake not to pay up to own those businesses. And, of course, that’s also been another problem I've had, is that the cheapskate, the built-in nature in me, makes it hard for me to pay up for truly great businesses. And I think that's another lesson I keep trying to learn, is that in some cases, it makes a lot of sense to pay up.
Holly: Wise. And I don't know if we want to predict the future, but somebody did ask, if you wanted to, what's the best market to invest in for 2019 to 2025?
Mohnish: It's just not the way I think about things. I think the thing is that this is a game about individual businesses, and individual people, and individual teams. It is not a game about picking a particular market, or a particular geography. I think that's the wrong way to look at it.
Holly: Okay. No crystal balls.
Mohnish: And so I think if someone is kind of looking for kind of where to invest, or so on, I think what they should do is -- a good way to narrow the list is, look at the highest conviction ideas of the investors you admire the most, and start with those.
Holly: Okay, which I would mention you can do on GuruFocus. I'll just put that out there.
Mohnish: Absolutely. East or west, GuruFocus is the best.
Holly: We'll start using that, [laughter] thank you.
I think this is a good one, because I remember reading about Prem Watsa (Trades, Portfolio) saying that he had an investment in CIB Bank in Egypt, and the currency risk really cut back on his returns. So somebody asked, “How are you managing INR-USD currency risk? Currency depreciation alone over the long run can wipe out a big chunk of returns,” they say.
Mohnish: Yeah, so we have never hedged currency, and I don't think we will. I think it's generally-- and especially with the Indian rupee, it's not cheap to hedge it. I think that if we are right on the business, then the currency won't matter. I mean, the Indian rupee over time is going to weaken, so we are going to face some loss of value from just the rupee. But I think that if we are right on the businesses, then it will not be relevant.
Holly: I see. Okay, well, we've taken up a lot of your time, and I really appreciate it. This has been extremely informative. We always like to sign off by asking people their book recommendations. What are you reading right now?
Mohnish: Well, I think this is a very old book, maybe a couple of thousand years old, “The Art of Living” by Epictetus. He was a slave, one of the stoics, and that's what I'm reading right now. And actually, the funny thing is, when I’m reading the book, I feel like I’m really reading Charlie Munger (Trades, Portfolio). So it's actually almost like all his prescriptions for life.
Mohnish: And I think that’s not a coincidence because I think Munger is very influenced by him. And so it's almost like I read it and say, “Oh, so this is where Charlie got this, and this is where Charlie got that." And it's a very thin, easy read. And the thing about him was, unlike all the other philosophers is, he was a slave, and then his owner actually saw potential in him, got him educated, and so on. But he talks in very layman terms, so he's not laying out high-flying philosophy. So it's in very basic terms, but it's very powerful.
Mohnish: Yeah, and it's a quick read, I think it’s just maybe 60 pages or something.
Holly: Oh, great. I will check it out. Well, thank you again, I really appreciate it. And yeah, we'll talk to you soon hopefully again.
Mohnish: All right, sounds good, thank you.
Holly: Good luck with everything. Okay, bye-bye.