MOHNISH PABRAI 00:00
I started my journey as a value investor 22 years ago, and I quite by accident heard about Warren Buffett for the first time. Unlike you, when I heard about him, I was 30 years old so I was much older. And when I read about him I was really stunned. I basically – So I haven't been to business school. I'm an engineer by training. All of you probably know a lot more about finance than I do. But I was really stunned with Warren Buffett's approach and the way he had been so successful.
And the crux of his success, at least what I took away from what I read in 1994, was a quote by Albert Einstein which is, "Compounding is the 8th wonder of the world." And so even though Einstein was a physicist, he actually figured out a few things about compounding. And obviously, in '94 when I had read about Buffett, he had been compounding at the rate of about 25-26% a year.
And 26% is a magical number. And I thought of the magical number then because if you compound money at 26%, it doubles in exactly three years. So if you have $1,000 and you compound at 26%, you're going to have $2,000 in three years and so on. And if you go for 30 years that's 2 to the power of 10. And this group doesn't need me to tell you that 2 to the power of 10 is 1,024.
So we throw away the 24 and it's 1,000 times your money. So if you had $1,000 and you compound it at 26%, 30 years later you would have $1 million. And if you had $1 million and you compound it at 26%, 30 years later you'll have $1 billion. That's basically the key to Buffett's success.
And so I wanted to – I thought it was worth trying to do what Buffett did. Of course, there’s no way that we're going to have another Warren Buffett. But I thought it was worth trying to compound at high rates.
And so I actually gradually over five years, I switched from being a CEO of an engineering company to eventually being a hedge fund manager. And the key nuance, or you can say mental model I used was very simple. Which is I looked for companies that were selling for half or less than what they were worth in two or three years.
So if I could find a dollar bill for 50 cents then what that meant is that if it got valued as a dollar in two years or three years I would be compounding at 26%, and if it happened in two years, it would be even higher. It'd be like 35-36%. And if it happened in (three) years, it would be 26%.
So I said it's worth trying to seeing if we can find these 50 cent dollars because 26% sounds high. But finding things that are half off in an auction driven market is not – I didn't think it was that hard and I thought it was worth trying because the rewards are so high. And so that's what I embarked on doing is I said, "Okay, let's try to find these dollar bills for 50 cents." And then you just sit back and wait for two years or three years.
And, you know, markets are a weighing machine in the long term and they'll get reweighed accordingly. And for the most part, if I look at my performance from '95 until let's say 2014, it's done about the 26% approximately. The last two years I'm down about one-third, so we were taken down a little bit. But we think in the next few years we'll make it up. So we'll see how it goes. I'll report to you next year when I'm with you in-person.
And but this journey it’s been 21 years since I started doing this. And I had a million dollars in '95 and I wanted to try to see if that million in 30 years could convert to a billion. So I said, "Okay basically, we have the million, I don't really need it for anything. I'm going to try put it in this Buffett engine of compounding and I want to see what happens to it."
And the good news is that even if I miss by 90%, it's still a big number. Even if I miss by 95% it's still a big number - they're all acceptable numbers. So it sounded like a good game to play.
And when I first set up my first set of stocks I bought in 1995, and this is – you know, I had one year of experience reading about Buffett. I didn't have a lot of experience. I hadn't gone to business school cetera.
And so I basically used to just – if I found a company, I would make a 10% bet. So in my portfolio of a million stocks, basically $1 million got divided into 10 stocks. Okay, and so I bought these 10 stocks but then I had an interest at that time in making investments in the Indian market because there were some companies I had noticed in the Indian stock market that looked very compelling.
And it was very complicated at that time in '94-'95 to invest in India, especially as a U.S. resident. And for example, they didn't have Demat, so if you bought shares – this is like 21 years ago – they gave you physical stock certificates.
And also the Indian government said that if I brought in dollars and I bought Indian stocks, I'd be able to take the money back without taxes back in dollars. The country had a lot of exchange controls, so I didn't actually believe them. You know, I was a little skeptical that a country that would have all these exchange controls would kind of honor these things that they were saying, if you will.
And so I was skeptical, so what I did is out of the million dollars I only allocated $30,000 to India. And the $30,000 I allocated to four stocks. So I had to physically go to Mumbai. I opened a broker's account, opened a bank account and then I bought these stocks. And then a few weeks later I got these physical stock certificates in California and they were almost falling apart. They looked like they almost were worthless, they looked so beat up.
And so one stock I bought which was half of the $30,000 – $15,000 – was an IT services company, that was the business I was in. And Satyam Computers and then three others – there was one – one was a broker to whom I bought the stocks and two were courier companies kind of like FedEx or DHL because India had a very bad postal system.
So I thought that as the economy grew these companies that were basically doing what the postal system should be doing but are doing it in private ways like FedEx and DHL and UPS would also grow. So and I thought these were all very long term plays.
So when I got these certificates I said, "Okay, I'm going to stick them in my drawer and not look at them for 10 years – just let them be. But what I noticed is after about 5 years, one of the stocks the IT company – Satyam Computers – I bought it for ₹45 and it was trading at ₹7,000. It was up 130 or 140 times what I paid for it.
And at that point actually I had been tracking it a little bit, but in about 1999, which was about four years after I bought it, I said, "Let me just study this business again because I know the business but this is ridiculous." And I noticed that the multiple it was trading at, was trading at more than 100 times earnings. It was just ridiculously overpriced.
And one of the reasons it was priced that way is because they had spun off a dot-com company which they still owned a piece of. And the market at that time was in a major bubble for all these dot-coms.
So this company which was just a system integration IT company had spun out a subsidiary which was doing some nifty things on the web. And the market gave that spun out company a huge valuation and because of that, this company got a big valuation.
So anyway, I thought this was complete bubble territory and I was also concerned with the $15,000, and the exchange rate had moved against me. The $15,000 was worth over $1.5 million.
So you know, I had started with $1 million. I will tell you about the remaining $985,000 in a second but $15,000 of the portfolio was sitting at $1.5 million. And I was concerned whether the Indian government would allow me to take the money back, whether I could even even sell the stock, and whether the shares were fake or real.
I had a lot of questions. So I said, "You know what? We're going to test this out." So I contacted the broker, and I said, "I'm ready to sell these shares." And I sent them the shares, and they sold the shares. I sold within 5% of the all time high of that company, and they put the money in my Indian bank account. And then the next day I asked them to wire it to the U.S., and they wired it. Everything went flawlessly, exactly as the government had promised no issues. Okay, I was blown away. I said, "Wow, no taxes?" I gave them $15,000. Five years later they're giving me $1.5 million with no questions asked. What a country!
And then the other stocks that I had they were all kind of, you can say old economy stocks. And they hadn't done much, so the remaining $15,000 maybe was worth $20,000 or $25,000. It had not moved much. In fact, everything else was going down in price at that time except the frenzy for the dot-coms. Even Berkshire Hathaway hit a multi-year low at that time.
And so in 2001 I decided to completely exit my Indian positions and I sold all the remaining three. One of them was down 50%, but the other two we made a little bit of money. Basically, for the remaining $15,000, I got about $20,000 back or something. And the overall result in India obviously was more than acceptable. You know, $30,000 in, $1.5 million out is perfectly fine.
Then the other $970,000 I had, there was one company I had in there which went up 100x. And I had $100,000 in a U.S. company, CMGI which went up 100x. So that one company became $10 million. And so now I had $10 million in that one company, I had the $1.5 million in this one Indian company, and the rest of the portfolio had done okay because at that time from '95 to 2000, the U.S. markets had gone up like 25% a year. So that it had moved up, but nothing like these other companies.
So I had like, you know, I think $13-$14 million out of the million dollars in 5 years. And I said, "Mohnish, forget about 26%, we've just blown it out of the park. Very well done. Good job." I was very happy. You know, it was a fantastic job. Especially for never having even attended a single class of the professor at Peking University. Just, you know, winging it on my own, if you will.
And now recently I went back, so what happened is these other stocks when I went to sell them – the other three Indian stocks – they told me one particular stock certificate was fake. So it was a very small amount of shares but they said it was a fake certificate and the broker said, "We're not responsible for fake certificates." So I didn't really care, it was a small amount. I just kept that one certificate in my desk.
And recently I looked at it again and I said, "No, it doesn't look fake to me." So I sent it again to a broker in India to sell and I asked them, "Can you sell these 100 shares of this company?" So now what it happened is I had held this one company, Bluedart which is the FedEx of India for 21 years.
And I held it for 21 years by accident because that one little piece didn't get sold because of this kind of fake thing. And I trace back because I kept getting these dividend checks all this time and all that. That Bluedart was ultimately a 60x.
So if I had kept those shares – I’d invested in Bluedart, I’d invested $7,700 – And I would have had about half a million. If I had kept those shares. So then I went back and said, “let me check all the four stocks in India, what happened to the other three if I had not touched them?” Because they were designed to not be touched, I was stupid, I sold it after six years. So what ended up happening is that Bluedart was 60x.
There was another one, Kotak Mahindra, which was my broker, that was up 50x. And the third one which was Skypack, which was a competitor to Bluedart, that basically went down to half – that didn't do anything.
But what ended up happening in the portfolio of 14 stocks in 1995 is I had a 4 out of the 14 that all eventually went up more than 50 times. And in one of them, I had a serious position – a 10% position – which completely altered my net worth. And then I started thinking that, you know, this is not good that I ended up with these companies in my portfolio and I never recognize how great they were.
I recognized it in two cases. In two cases, I was able to – Now, in one case I... In fact, in both those cases, I cashed out the 100x. Both because of the bubble. Not because valuations went up. They probably should have been worth 10x or 15x but not 100x. But so we over – we kind of collected more than we should have, which was fine.
But these other ones, these were real businesses, like the FedEx of India, the Goldman Sachs of India. And these were businesses I should not have sold, and I sold them. And so I started thinking, "How often has this happened in my portfolio?
How often has it happened where we've had these companies I was smart enough to buy them but not smart enough to hold them. And why is that happening?" So what I – Which is the subject of the talk today is kind of a framework what I did is...
So, you know, the best way to learn is to teach, so I have to admit that one of the reasons I wanted to do this talk and this lecture is because I'm trying to learn. So whether or not any of you guys learn anything from me, I am definitely going to learn from this talk. Because what I want to do is – I'm 52 years old, and hopefully, I have another 30 or 40 years left. And in the next 30 or 40 years when these 100-baggers show up in my portfolio, and they're guaranteed to show up, I hope I am at least smart enough to figure out that some of them are 50 baggers or 100 baggers and I hold on to them and not sell them.