DNA of a superinvestor
Posted on July 2, 2007 by Richard Beddard
Filed Under Markets, Reading list |
Whilst searching Amazon for classic value investing texts, Eddie Bravo of Vale tudo investing blog, discovered that two ‘must-read’ books, both out of print, were selling for considerable sums. Seth Klarman’s ‘Margin of Safety’ was going for $1,700 (It’s a bargain now at $1,400) and Mohnish Pabrai’s ‘Mosaic’ sold for $340 ($299 today).*1
You might think the price on Klarman’s head the more remarkable, but Mr Bravo calculates buying and holding ‘Margin of Safety’, published in 1991, would have made you 29% a year. In just three years since its publication, ‘Mosiac’ has put on 144% a year. Imagine the return per page, it’s only got 138.
Admittedly falling prices indicates the sellers have allowed a certain amount of hype to enter their thinking and not left a ‘margin of safety’ for buyers, but the price on his book is only one of a number of indications that a cult is developing around Mr Pabrai. He’s all over the Internet.
No doubt one of the reasons is his new book, ‘The Dhandho Investor’. Value Blog Review likes it:
If you want a book to help you understand value investing, this book can help you accomplish your goal.
The Value Quest blog is collecting interviews with Mr Pabrai. Watching them sheds some light on the cult. But first, you’ve got to admire a pundit who, unphased by the incredulity of his Bloomberg hosts, won’t be drawn into breathless comment on recent 100 point moves in the stock market:
“That’s in the noise level,” he says, “If the Dow moves three or four thousand points… that might change the behaviour of what I might look at…”
Investors, says Mr Pabrai, should think like a businessman (not a Bloomberg presenter, evidently):
“I talk in the book about this concept of low risk, high uncertainty. So there’s a perception that entrepreneurs are risk takers. Well, in reality entrepreneurs avoid risk. They try to minimise risk… They do absolutely everything to absolutely minimise the downside. But they are also humans that are very comfortable with uncertainty. So they can believe a wide range of outcomes and be very comfortable.”
Minimising the downside means buying stocks that are hated and unloved, that have already reached a ‘floor’. Sound familiar? It should. Mr Pabrai describes himself as a follower of Warren Buffett, often described as the World’s greatest investor:
“I’m just a humble disciple, or like you say I’m a shameless cloner.”*2
One of Mr Buffett’s many insights runs against conventional investment thinking, and by the sound of it, its the origin of Mr Pabrai’s contrarianism. Conventionally, risk means volatility (measured by a share’s ‘beta’), so a falling price makes a share more risky. But, as Mr Buffett explained, in a speech at Columbia Business School in 1984, subsequently printed in its magazine, in a value portfolio the bigger the expectation of reward, the lower the risk.
For example, In 1973 the Washington Post Company had a market capitalisation of $80m although its assets were worth at least $400m:
Now, if the stock had declined even further to a price that made the valuation $40m instead of $80m, its beta would have been greater. And to people who think beta measures risk, the cheaper price would have made it look riskier. This is truly Alice in Wonderland. I have never been able to figure out why it’s riskier to buy $400m worth of properties for $40m than $80m.
Mr Buffet was paying homage to a concept developed by Benjamin Graham, the father of the cult of value investing*3. That concept was the ‘margin of safety‘, purloined by Seth Klarman for the title of his book. Mr Buffett explains it this way:
You don’t try and buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And the same principle works in investing.
In other words, the lower the price relative to the company’s valuation, the higher the margin of safety. A low price reduces risk. If you watched the interview with Mr Pabrai, you’ll have noticed he really has shamelessly cloned that model, passed down, as it were, from Graham, to Buffett, to him.
So why listen to Mr Pabrai, when you have the works of Benjamin Graham and Warren Buffett? Well, Mr Graham died in 1976, so the focus must, to an extent, switch to his disciples. Mr Pabrai is a relative newcomer having started in 1999 with $1m. $100,000 invested in his fund then, would be worth about $720,000 now, he says.
Followers of Mr Buffett, meanwhile, have two problems.
- Berkshire Hathaway owns whole businesses as well as shares in them. So it’s not possible for most investors to ape Mr Buffett.
- Berkshire Hathaway is so big in relation to most of the companies in the stockmarket that, even if he did acquire them, they’d be insignificant.
That means Mr Buffett is severely restricted in the investments he can make, as he explained at the most recent annual meeting of Berkshire Hathaway*4:
If I were working with a very small sum – you all should hope this doesn’t happen – I’d be doing almost entirely different things than I do. Your universe expands – there are thousands of times as many options if you’re investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money. Everyone can’t do it, but if you know what you’re doing, you can do it.
Mr Pabrai, on the other hand, says he typically invests his fund in only ten companies, putting $50m in each*5. We may not have $500m. But a ten share portfolio is something we can relate to, and we can dream of turning £10,000 into £720,000.
Footnotes:
- If you’re seriously considering shelling out over the odds for a book, beware. I remember trying to buy a copy of ‘The Zurich Axioms’, then out of print, four or five years ago. I balked at the asking price of several hundred dollars. Soon after a new publisher bought the rights and republished it. You can buy a shiny new copy now for £6.99.
- According to this article, Mr Pabrai has just paid the best part of $650,000 for lunch with Mr Buffett; “I’ll probably download the menu and see what we want so we don’t waste our time looking at the menu,” he reportedly said.
- Peter Temple recently profiled Benjamin Graham on the Interactive Investor mothership.
- See page 26 of Whitney Tilson’s notes on the 2007 Berkshire Hathaway meeting.
- Guru Focus has a detailed article on the ten share portfolio strategy, and appears to be serialising. transcripts from the Pabrai Funds annual meetings.
- The Pabrai portfolio on Stockpickr.
- Correction: I originally wrote Mohnish Pabrai was interviewed by CNBC, but the quotes I used were from Bloomberg. I’m sure CNBC wouldn’t be so ‘breathless’! Thanks to George, who pointed out the error on Value Investing News.
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I wonder if I can order Mr. Klarman’s book from the local library (I can just imagine them spending one years council tax on a single book even, if it did increase the net worth of its constituents)
I was actually reading a great piece of advice in the FT today. It was only sentence so the rate of return may be even greater than Klarman’s.
It said
“… the public would be best served by frequent reminders that wealth accumulation comes from saving as much as possible, diversifying asset classes and minimising costs.”
Words to live by!
Moving on (quickly) I was trying to think what bothered me about value investing (I am no good at it so please do not assume this is anything deep).
The problem with value investing, as far as I can tell, is that you can never be sure when the value will actually be recognised.
For example, the value of the Washington post would have only been worth 400 million if it was sold. As far as I know it is still going strong today.
I am not sure if the fundamentals of the business have really changed so much over the years.
Therefore, is this a better investment because the business is fundamentally good (better than another similar company) or because the assets are more valuable than the business and Warrant Buffet has made sure everyone knows this?
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