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Collection: Mohnish Pabrai - #6 'Stock Market is an Auction-Driven Market'



I'm glad we're getting to the like the core issues right up front. So you know, I don't have a newspaper in front of me, I should have brought one. But because I'm – one of the thing, in fact that maybe in my next presentation sometimes.

This is my plan for my next presentation to answer that question. I want to take like the Economic Times or Wall Street Journal or whatever. and I want to create a dart board out of all the the stock quotes page.

You know, create a dart board maybe I'll actually create a real dart board. Have some unpaid intern to do that and then what I wanted. I want to take a dart and throw that dart on that dart board. And whatever stock lands on, I want to take that stock and just give you the statistics of that stock.

So let's say, let's take a company in the U.S. like General Motors. You know, huge company car company around. Close to 200 billion in sales – 150 billion – I think 200 billion sales.

So if you look at the 52-week range on GM, General Motors. And you can do the same thing with Infosys. You can do it with [Inaudible], you can do it any company we will just throw a dart basically.

And what you find is that in 52 weeks which is in one year, the time Earth go around once. General Motors was at one time being valued at $18 a share. And in fact, just yesterday it hit a 15th week high, it's at over $36 a share. So in one year on this one stock, you have basically pretty much 50% movement. You know, you basically double the market cap from a year ago or whatever. So and the business the underlying business has not changed that much.

Okay, if I look at Infosys I don't know – you guys what are the price of Infosys right now?




I am sorry?




2800 rupees? And what's the 52 weeks low on it?


around 2200.


Okay and what's the 52 weeks high?


I guess is the high –


So it's 2200 to 2800?




Right okay, so you have a range of like 30% or something. Okay, the reason you have these ranges – now if you look at any other asset class. so let's say I have a 3 year old Maruti car. Okay? The price I could get from the car a year ago. 3 year old Maruti and the price I could get today. Again the same 3 year old Maruti may be within five ten percent of each other.

Okay, even for the most part real estate. Movement is low.

Stock markets are different creatures and the reason the different creature because they are auction-driven markets. So you don't – in the case of a car you have an intended buyer facing an intended seller. And between the intended buyer and the intender seller they will arrive at the price of a car that makes sense. And if they don't arrive at intelligent price there will be no transaction.

So both sides have to agree. In the case of the stock market, you are basically faceless buyers and faceless sellers and you have auction driven mechanism for setting prices. And auction driven mechanism by their very nature are set up to create distortions.

And Warren Buffett has benefited big-time from those distortions. So if there were no stock market, Buffett could not have done what he did. If let's say Warren Buffett were restricted from 1950 till today to only buy private companies from intelligent sellers.

No way, no way anywhere close to what the record is today. It is because we have this mechanism of this auction driven market that we have this distortion. So if I went to buy GM a year back and I went to them today the price will not change a 100%. Okay, it will change 5%.

Even in the case of Infosys, you go buy the whole company and they give you a price today and you hold more than six months from now, the price will not change that much. So bottom line is that it is the auction driven nature of these markets that causes these wide distortions.

And the second is that especially when there is extreme fear or extreme greed, you will get attenuation of that distortion. So it enforces something for example which is a blue chip company.

But what if I pick something that is an obscure company?

You know, let's say I pick some you know, regional jute producer in Calcutta. Something 100 crore market cap like that, it will have a wider distortion. Okay but that same company if you go to a private transaction to buy the company.

You are not going to have those disruptions. So the stock market is set up for cloners like me to have a feeling. So you know, same thing you see in the public market you know. Facebook comes public, everyone is excited about Facebook the stock price goes up like crazy. And then a few months later, no one's interested and that goes on all the time.

So markets are constantly overshooting. Sometimes where they significantly overvalued the companies or they significantly undershooting [Inaudible]. And because of the significant over and undershooting you can sit there. So bottom line is that if you have that much of a swing 50% or 100% percent swing in a year.

It means that there are enough companies out there that are not correctly priced at any given time. There are either underpriced or overpriced. And especially if you overlay on top of that distress.

Some kind of temporary situation which affects that business that will cause even more attenuation of the pricing. Because the other thing that's happening in public markets is that any company typically in about two years, sometimes in one years, sometimes six months, the entire turnover – shareholders' base changes.

So all these things basically mean that some yo-yo like me, can sit there spend most of time talking to you guys or hanging out with Dakshana scholars. And every once in a while I see distortions of an extreme nature. And when I see distortion of extreme nature then I act decisively.

And I don't need to be right all the time I can be – in fact John Templeton who was a great investor said that there's no investor who's right more than two or three times so you can be wrong plenty of times and you can still do fine. So I think that you know, these distortions take place all the time.

I think if you understand the business really well. First, most important thing is circle of competence stick within the things that you understand really well. If you understand things really well you know what they're worth.

And when the world is valuing it much below, what it should be worth at. That's when you act to buy. And when the world is valuing it significantly above what it's worth at then you sell it. You're done nothing else to do. So maybe you have 2 or 3 buyers a year, 2 or 3 sellers a year and we move on from there. Next question?



[YAPSS Takeaway]

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