TIP550: Masterclass w/ Mohnish Pabrai

Investors can learn from Mohnish Pabrai's successful methodology of separating signal from noise and understanding the overall process of investing. Although it's difficult to stay objective when processing information from people who are admired, it's important to be aware of our biases as humans. Our brains have a lot of quirks and biases that can hinder our ability to be great investors. It's important to be aware of these pitfalls and try to sidestep them as much as possible. However, it's impossible to avoid all of these biases. By reading Charlie Munger's essay on the Psychology of Human Misjudgment and Cialdini's book, individuals can be informed of the pitfalls that can arise during the investing process.

In the stock market, efficiency of a market is affected by the holding period of stocks. In Turkey, the holding period is only an average of nine days which poses a challenge for the market to revert back to intrinsic value. However, in the long run, all companies get correctly valued, and undervalued ones go up while overvalued ones come down. This principle applies globally because the stock market is a weighing machine in the long run and a wording machine in the short run. It's important to be aware that our brains don't always follow a rational path, making it helpful to re-read information over time to retain valuable insights. Additionally, learning from peers, students, and experts will help in making informed investment decisions.

To achieve success in investing, it's important to weigh companies and not just dance in and out of them. Mispricing exists due to fear and greed, but it's much less in the US than many other places. When reading annual reports, start by looking for reasons to say no and then follow a four-step process to filter out the best businesses. Mohnish Pabrai is on track to study 50 new businesses in 2023. A new approach he is excited about is the circle the wagons approach, focusing on a few truly extraordinary businesses instead of many mediocre ones. Most of the great outcomes for Berkshire have come from just 12 decisions made over 58 years.

Investing is not about making a lot of good decisions, but making a few great ones. Even great investors like Warren Buffett have a hit rate of only 4%. This means that picking the right few companies to invest in can have an outsize impact on returns, even if the rest of the portfolio goes to zero. For example, if Rakesh Jhunjhunwala had invested only 4% of his portfolio in Titan Industries in 2003, it would have grown to 1.4 billion, even if he had chosen poorly on all other investments. Investing in the right companies is more important than diversification and over-diversification can dilute the impact of great picks.

To succeed in investing, it is crucial to identify businesses with great economics at reasonable valuations and hold onto them forever, without touching or selling unless they become egregiously overpriced. The 'circle the wagons' framework of defensive posture from the pioneers and settlers on the American frontier is fundamental to this approach. Mature businesses with a lot of history, such as Naspers in South Africa, have shown exceptional returns when they make a massive bet on a company, hold onto it and do not sell unless it is completely overpriced. The key things to remember in investing are that mistakes will be made, but the forgiving nature of the business allows investors to come out smelling nice if they hold onto the right companies.

CEOs may not be great at capital allocation and may struggle to buy back shares below their intrinsic value due to their optimism and lack of expertise. However, founders who understand capital allocation and have a long-term outlook can make informed decisions about buying back their own stock. One example is the founder of Shinoken, who eventually took Mohnish Pabrai's advice to retire significant numbers of shares at a spectacular discount to the business's worth. Founder-run businesses like Shinoken and those with strong recurring revenues and a long visibility into cash flows are exceptional businesses that are great to invest in. However, investing in Japan can be challenging due to the business's focus on employees and demographic decline.

Japan's population is decreasing at an alarming rate with 1 million reduction in population in a single year. South Korea is also seeing an extreme decline. Companies need to make rational decisions to grow and make smart investments with their cash, such as buying back their own shares. CEO's need to have faith that their stock will rise in the future after implementing a buyback strategy. Lifelong learning is crucial for successful investing as there are many factors that can affect a business's long-term outcomes. NVR has done a wonderful job buying back shares and diluting them to management. S&P 500 has been issuing shares to management at a rate of 2%.

Stock-based compensation can dilute existing shareholders and is often an attractive option because it is non-cash. However, it is sub-optimal and can be avoided by setting compensation and incentives without giving out equity. Encouraging management to buy equity like Constellation Software and Berkshire Hathaway, or implementing unique compensation structures like Mark Leonard's at Constellation can be effective in aligning incentives with shareholders. Larry Ellison at Oracle has taken a lot of stock-based compensation that is an add-on tax to shareholders, whereas Bill Gates at Microsoft has always had a modest salary and never granted himself any options. Accounting has forced companies to treat stock-based compensation as an expense, but companies still rely on adjusted metrics.

Constellation Software is an exceptional company with a unique business model, led by an exceptional manager. Their strategy of acquiring stable and slow-growing companies that are not of interest to private equity or venture capital is an effective way to generate returns. With an internal list of 40,000 small companies, they nudge them a few times a year and acquire when founders want to retire or move on. The company is in the funeral business - taking care of the businesses that nobody wants. Constellation has a range of ways to help the acquired businesses but does not impose themselves on them. Overall, Constellation Software's business model and execution make it a trusted long-term investment.

Investors should accept the high error rate in investing and separate the signal from the noise by looking at a good amount of data to determine if they were wrong. If the signal suggests that they were wrong, it's best to cut losses and move on. In the case of Alibaba, actions by the Chinese government make it hard to predict the company's future, and the mega-cap status of the company calls into question its runway for growth. As such, investors should consider other investments, such as Process and Tencent, which may provide better opportunities for growth and higher returns.

To find successful businesses with high growth potential, it's better to focus on smaller companies that have room to grow. Building trust and developing deep relationships in business and personal life requires committing to the truth, honesty and integrity. Though the truth may be uncomfortable and even painful at times, it should be treated as essential to developing trust. Trust is what makes the world go round, not contracts, and in order to be successful in business, it's important to maintain high standards of candor and integrity. Friends and business partners do not stick around solely because of contractual relationships, but rather because they believe in and trust the people they are working with.

Being honest and truthful in personal relationships may feel unnatural and uncomfortable, but it leads to a lot of growth and a better sense of well-being. Candor is key in expressing your true feelings, even if it means saying no to certain social events or discussing uncomfortable topics like money. Being authentic in your interactions will be appreciated by friends and family who will understand and respect your honesty. Living in truth also simplifies your life, as you don't have to remember lies or keep track of inconsistent stories. While it may be challenging at first, adopting these principles will ultimately make life a lot more pleasant and meaningful.

People often avoid discussing their financial situations, but sharing this information in a safe and confidential environment can be beneficial. Mohnish Pabrai asks uncomfortable questions about finances, but people are often relieved to share the data and receive advice tailored to their situation. This allows for more objective and effective guidance. Conversations about money can lighten the load for those experiencing different issues, and it's important for those who can help to go to the land they're not supposed to and have these conversations. Stig and Preston's podcast provides a platform for important discussions and has done a tremendous service to the community. Talking about money may be uncomfortable, but it can be a game-changer.