Virtual Value Investing Q&A Speaker Series Event at Brown University with Mohnish Pabrai
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August 2nd, 2021: The sixth guest speaker for the 2021 Virtual Value Investing Q&A Speaker Series Event at Brown University, Mohnish Pabrai, is interviewed by the host, Itai Parnes.
0:00 Introduction 1:12 Characteristics of Spawners, Indian Energy Exchange, Tencent, Berkshire Hathaway, Capital Allocation 11:35 Chinese Big Tech Regulation, For-Profit Education in India and China 18:36 Searching for Clones of Great U.S. Companies in Other Countries, Payment Systems 22:15 Great Business Models, Monopolies, Coca Cola Bottlers 26:39 Compounding Money at 50% Per Year 43:40 Starting a Fund, Raising Capital 48:15 Stellantis and Exor, Ferrari 50:21 Mohnish Pabrai's Sunteck Realty vs. Guy Spier's Mastercard Competition 51:30 Zen and the Art of Motorcylce Mantainance 53:40 Books About Startup Founders and CEOs
Disclaimer: This video is provided for informational purposes only. Nothing contained herein should be construed as an offer, solicitation, or recommendation to buy or sell any investment or security, or to provide you with an investment strategy. Nor is this intended to be relied upon as the basis for making any purchase, sale or investment decision regarding any security.
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Manish Pabrai argues that successful investors should focus on finding deeply undervalued assets ('winning tickets') through systematic analysis within their circle of competence, prioritizing capital-efficient businesses with strong cash generation and redeployment engines ('spawners') over mechanical filters.
- The most valuable companies are those with internal spawning engines that redeploy cash into high-return businesses (Tencent, Amazon) or external acquisition engines (Berkshire Hathaway) rather than those forced to dividend or buy back shares
- Success requires passionate, disciplined searching for statistical anomalies that others miss, modeled on Buffett's systematic review of thousands of companies in Moody's Manuals and Pabrai's own discoveries of deeply mispriced assets in Turkey and India
- Small-capital investors can achieve 40-50% annual returns by hunting for extreme discounts (assets trading at 30 cents on the dollar), but must then graduate to larger opportunities as capital compounds, leaving the opportunity set to new entrants
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Berkshire Hathaway did not issue dividends or buy back shares from 1965 until very recently (only one 10-cent dividend in its entire history), despite being an extraordinary capital-allocation engine, because it successfully found enough acquisition and reinvestment opportunities to deploy capital effectively for over 40 years.
“the workshop from 1965 till now has never issued a dividend i think one time profit i think the record indicates that they one time issued a dividend of 10 cents and buffett said that he must have gone to the bathroom while the board made that decision”
Some businesses have such strong moats and favorable competitive dynamics that they can be extremely poorly managed and still generate excellent returns, whereas most capitalism is 'dog-eat-dog' and requires exceptional execution; Coke bottlers exemplify the former, window-cleaning services exemplify the latter.
“some businesses are in this very favored situation where the the mode is wide and deep and can endure for a very long time and it generates higher returns and equity and most of capitalism is not like that most of capitalism is dog-eat-dog it's really tough it's difficult”
Mechanical filters for stock selection are generally not a good investing approach because the real world and individual businesses are messy, requiring qualitative judgment rather than pure quantitative screens.
“anytime you uh mentioned to me uh mechanical filters i cringe uh so uh in general uh it's probably not a good approach uh to investing because uh the real world is messy and uh and individual businesses are messy”
When investing in statistically cheap assets (low P/E, below book value), mechanical quantitative metrics are only the beginning—the critical next step is rolling up sleeves to verify (1) whether the opportunity is within one's circle of competence and (2) whether the discount reflects reality or justified pessimism.
“when we find things that are statistically cheap it's only the beginning of the hunt uh when something is statistically cheap and it can be cheap in a number of different ways we then have to roll up our sleeves and the first question we're going to ask ourselves is what i'm looking at is it within my circle of competence and can i figure this out okay and if the answer is yes then i can go further to uh the next question”
Charlie Munger made a successful investment in Tenneco in 2002 by buying deeply distressed common stock and bonds at 20-30 cents on the dollar, turning $10 million into $80 million in three to four years.
“charlie munger uh made an investment i think in 2002 in tenneco i was very distressed he he bought the common and he also bought the bonds and the bonds were at you know i don't know 20 30 cents on the dollar and even the common was really clobbered and it worked out extremely well i think i think in about three years three or four years after that he was the 10 million with 80 million”
Warren Buffett as a teenager would attend the Ak-Sar-Ben racetrack in Nebraska, collect discarded lottery tickets from the ground, and have his aunt cash winning tickets on his behalf (since it was illegal for him to bet as a minor), exemplifying his intrinsic drive to find undervalued assets.
“warren buffett was a kid he used to go to the ex-sarban race track in nebraska and the examined race track excited as nebraska spelled backwards and in fact one year i think i went to the berkshire meeting i think in the uh late 90s or early 2000s the meeting was at the examiner track it the track had closed down and become a meeting venue so he used to go to the racetrack and uh he had a number of different interests in horse racing but one thing he was very interested in at the end of the races he would pick up all the tickets that people had thrown on the grounds”
US payment systems are significantly more archaic and carry far higher friction costs than payment systems in China or South Korea; merchants in the US must pay 2-3% of revenue to Visa/Mastercard while banks and other payment methods cost 95% less.
“payment systems in the us are way behind payment systems in almost any other part of the world payment systems in china are extremely advanced korea very advanced and actually in many ways the u.s payment system is very archaic and and it has an extremely high frictional cost”
Payment systems are an area of rapid global change; while US systems are strong with durable moats (Visa, Mastercard), they face transformation; other countries have rapidly advanced payment systems (China, Korea) and are developing their own enduring moats (Alipay, Tenpay), requiring investors to treat payment system investments as moving targets.
“i think payment systems uh in general are an area of rapid change globally uh some of the most in in the us are pretty strong but they're going through a lot of changes all around the world and so um yeah so when you're investing in in payment systems uh you have to be aware that uh it's a moving target and uh and sometimes you can end up with very deep enduring modes like the wavies and mastercard did um but uh and and you know to some extent even you can say alipay 10th and paid they've also you know developed some great modes uh but but it can it can shift uh those are industries that rapid change so one has to be a little careful”
Amazon and Berkshire Hathaway represent contrasting capital-allocation models: Amazon's primary redeployment is internal (spawning new enterprises and ventures), while Berkshire's is external (acquisitions and investments); internal spawning requires high managerial innovation and hit rates but avoids depleting external acquisition targets.
“the difference between let's say a berkshire hathaway and let's say an amazon the difference between these two is in the case of amazon the redeployment of the cash generated is mostly done with internal projects so they basically are spawning new enterprises and new new adventures and so on in the case of berkshire a lot of it is acquisitions um not that much coming from internal readme they do have some amazing businesses that are redeploying internally etc but for the most most part they've got to go externally”
Chinese government regulation of for-profit education companies is justified and healthy because the tutoring industry, similar to India's, creates perverse incentives where competitive parents overspend on tutoring, making large families economically unfeasible and reducing birth rates in ways that harm national demographic goals.
“the government has its heart in the right place when it says we don't want this kind of a system because it it reduces uh people's interest in having a reasonable size families etc which which goes against the country's things”
Undervalued investment opportunities ('winning tickets') exist in plain daylight globally but are ignored by local investors; international investors can capture these by crossing borders and doing the analysis work that locals won't, as exemplified by Pabrai's 2019 Turkish company discovery (20M market cap, 600M liquidation value) and 2015 Rain Industries investment.
“in 2019 i was visiting turkey and i i visited this company where the market cap was 20 million and liquidation value was like 5 600 million hallelujah we're at the ex-sovereign race track and except that in this case there's millions and millions of dollars on the ground nobody wants to pick it up the entire country of turkey 80 million people have no interest in picking up these example tickets”
Mastercard conducts numerous acquisitions and generates strong net-income-to-revenue metrics, but still accumulates excess cash that exceeds productive acquisition opportunities; the company continues to repurchase shares despite trading at very high valuations (40x+ earnings) because capital redeployment options are exhausted.
“mastercard does a lot of acquisitions they have very high you know net income versus revenues et cetera fantastic business um but they still end up with lots of cash and even though the business trades at a very high multiple they still continue to buy back share because they've got no other option so it's way better to buy back mastercard stock at 10 times earnings than 40 times earnings but even at 40 it still works”
Indian Energy Exchange (IEX) spawned Indian Gas Exchange as a follow-on business opportunity, demonstrating the company's capacity to create new revenue streams; however, both businesses require minimal capital due to their exchange-based models, limiting their utility for capital redeployment even if successful.
“they've the first spawn they've created is indian gas exchange uh which they're trying to grow and scale but by its very nature indian gas exchange hardly needs any capital it's like indian energy exchange that also hardly means any capital so even if it's really successful it will not be able to use the camera”
The hierarchy of capital allocation efficiency is: (1) internal spawning engines with high hit rates and high ROE businesses at the top; (2) buying or investing in other businesses at attractive valuations; (3) dividends or buybacks; with buybacks most powerful when done at modest valuations.
“if you look at the kind of the hierarchy the absolute best way to use capital is if you have a spawning engine internally that has a high hit rate and is spawning businesses that generate high returns on equity that's you know that's mecca you you hit the top spot there um the second uh the second is if you can't do that and you can buy or invest in other businesses or assets at you know valuations that would give us give you high returns in equity that's also excellent the third would be either dividends or buybacks”
Buffett's circle-of-competence discipline extends to his fund management: even when managing hundreds of billions of dollars, he recognized certain market opportunities (Japanese stocks, Turkish company liquidations) could not move Berkshire's needle and chose not to pursue them for the fund, but pursued them in his personal account, separating fund and personal capital based on opportunity size.
“it's like you know i told you the million dollar guys have to move up they can't stay there they're going to move up but the thing is he loved the hunt so much that he couldn't help himself and probably if he found something in there berkshire couldn't buy it he probably could buy it for his own account and he did that with korean stocks a few years ago where again it was the exact same thing it was quantitatively cheap and he couldn't help himself right”
Human personality, psychological traits, and preferences are hard-coded by age 5 and remain frozen through age 95; to live optimally, individuals must align their behavior patterns with their inborn traits rather than forcing misaligned behaviors.
“after the age of five it never changes so from the age of five to the age of 95 who you are and what your likes and dislikes and traits are are hard coded and to lead the best possible life you want to have your behavior patterns align with what your inborn traits are because inbound traits are frozen”
Tencent generates tens of billions in annual free cash flow and operates an internal investment arm (a 'sequoia fund on steroids') that deploys this capital into private deals at companies that have achieved certain milestones, avoiding large stakes to preserve optionality, with a track record of investing in 15-20+ unicorns and matching or exceeding the returns of top-tier venture capitalists.
“inside tencent is uh what i would call a sequoia fund on steroids so if they make uh 15 billion in a year you know free cash flow they have a biz dev arm that is going to take that 15 billion and deploy it into uh mostly private deals”
Even after being influenced by Charlie Munger to buy better businesses, Warren Buffett continued his extreme-discount hunting at age 80 while managing hundreds of billions at Berkshire (knowing it couldn't move the needle), because he loved the hunt itself—exemplified by his discovery of undervalued Korean stocks.
“he even even after he got influenced by charlie munger and he started buying better businesses you know probably i would say a few years back i would say maybe 10 12 years ago i was in his office uh with my friend guys pierre”
Investors who have already become wealthy through compounding should focus on raising capital from friends and family, with track record being the primary marketing tool—if returns are strong, investors will seek out the manager rather than requiring active solicitation.
“if you've got an engine which is getting you those high rates of return the power of compounding is such that if you never raised the fund you would still be enormously wealthy so uh the first i think the first criteria to getting into the fund business is you should already be independently wealthy and if you are not already there it means that something's happened in the past where it hasn't been proven that you can do this now if you're already wealthy um then i think you focus on the friends family and foods especially the fools okay”
Spawners are 'sitting pretty much at the apex of the pyramid' of capital allocation strategies, which explains why they are exceptionally attractive to value investors and why mechanical filters are inadequate for identifying them.
“spawners are basically sitting pretty much at the apex of the of the pyramid and which is why we like them so much”
Investors with small amounts of capital pursuing 40-50% annual returns must have an absolute target (e.g., double capital every three years, requiring ~26% annually) and can only achieve this by finding deeply discounted assets (buying for 30 cents on the dollar) rather than moderately undervalued businesses.
“if you have a very small amount of capital and i want to double it every three years for example what that means is you need to be generating about 26 a year or something so which means that you really can buy a business at 80 percent of intrinsic value because even with some growth and stuff it would be hard to get a double in two or three years um so but but if you were able to buy an asset which is worth a dollar but you were able to buy it for 30 cents uh that may lend itself to something like that”
Business biographies and autobiographies (especially of founders and entrepreneurs) provide invaluable learning about how to identify and evaluate businesses by showing decision-making through the lens of operators rather than analysts; reading these narratives teaches more than most business education.
“i would say that uh founders you know i would say sam walton's book uh i think that's really good you know business biographies and business autobiographies is probably my favorite genre uh because i just love them so much”
The Upanishads teach 'as is your wish so is your will as is your will so is your deed as is your deed so is your destiny'; therefore 'your deepest desire is your destiny,' meaning Buffett's fundamental desire to find every winning ticket people threw away became his destiny through persistent action aligned with that desire.
“we have these uh ancient indian texts the upanishads uh they are spiritual but i think they're very heavily philosophical and i think there's a quote let me see if i can remember it they say as is your wish so is your will as is your will so is your deed as is your deed so is your destiny and then the punchline is your deepest desire is your destiny so if you really really want something okay buffett really really wanted to find every single winning ticket that anyone had ever thrown away right and so he just went all in on that right”
Indian Energy Exchange (IEX) is a monopoly business with approximately 80% operating margins that collects roughly 1.5% of transacted electricity fees, currently processing over 6.5% of India's electricity (up from less than 3% when invested), with tailwinds from both increased per-capita consumption and the spin-off business Indian Gas Exchange.
“iex basically is a effectively it's a monopoly business and it allows the trading of electricity between generators and the discounts of distribution companies and they they collect an approximately 1.5 percent fee of the amount transacted um and and so uh basically uh currently i think i mean when we invested approximately less than three percent of india's total electricity usage was going through uh iex and now it's uh over six and a half percent”
Fintech companies like Affirm are attempting to disrupt Visa/Mastercard by spreading payments across multiple transactions to sidestep the 2-3% transaction fee structure, though the moat of these companies combined with consumer kickback mechanisms (airline miles, credit card rewards) makes disruption difficult.
“companies have come up like a firm and others which are basically trying to sidestep the visa mastercard ecosystem by saying okay let's spread the payments out three or four payments now that two percent is gone”
Pabrai's fund-raising strategy initially involved giving investors the implicit 'mission' of recruiting their friends and family as new investors, using the compliance constraint that he cannot solicit but can communicate with investor-referred contacts, which scaled his fund from 8 to 17 to 25+ investors.
“so we went from eight investors to 17 investors to 25 investors and we just kept going from there”
Chinese large tech companies are generally high-quality players, but historically operated in a regulatory vacuum ('wild west') where rules were undefined; government intervention to clarify and tighten rules creates a better ecosystem long-term without materially harming the best operators.
“in many cases the rules were not defined and so you know in a wild west scenario you're not really breaking any laws you're just proceeding with what's acceptable in the wild west and uh and so i think the chinese government coming down and saying hey wait a minute i think some of these things if we you know tweak it somewhat at the end of the day we end up with a better ecosystem and uh and i think that's what they're driving towards”
Pabrai spent 14 years closely examining the for-profit education sector in India through his nonprofit work with Dakshana Foundation, including having for-profit tutoring companies as vendors.
“in my non-profit adventures with the dakshina foundation i have spent 14 years examining the for-profit sector of education in india very closely and uh and we've even had them as vendors and you know paid them to provide services to our students etc we had a very long history with the indian let's say tutoring industry”
Pabrai has shifted his investment focus from 'PEO ones' (cheap, re-rating plays) toward 'compounders' (high-quality, long-term wealth-creation vehicles), reflecting a natural evolution in investment philosophy as he aged and his capital base grew.
“i was much more biased towards uh the peo ones and all of that when i made that bet and i'm more biased towards uh the compounders now uh i don't know if i would place that bet today”
Pabrai paid 650,000 with his friend Guy Spier to have a lunch with Warren Buffett, which was a valuable investment.
“mr probably is also famous for paying 650 000 with his good friend guy spear for an invaluable lunch with warren buffett”
Jim Senegal, founder of Costco, credits everything he knows to Sol Price, founder of Price Club, whom he worked for before founding Costco; Costco later acquired Price Club.
“jim senegal at costco used to work at price club then he started costco and then eventually they bought price club so they asked jim senegal i think a few years back what did you learn from sole price and he said you know it's the wrong question he says there's nothing i know that did not come from sole price so everything i know is from sole price”
China's regulatory approach to business can be characterized as 'innovation then regulation'—allowing market participants to develop new business models, then imposing rules once consequences become apparent; this differs from Europe ('regulation then innovation,' suppressing innovation) and the U.S. ('innovation with no regulation,' allowing unchecked externalities).
“there's a blogger i follow in china i think she was saying that and i i hope i can remember this correctly uh but she was saying that in china it was or it is innovation and then regulation and uh in in europe it's regulation and then no innovation uh and uh in the us it's uh innovation and no regulation”
Pabrai gives away approximately 2% of his wealth annually to the Dakshana Foundation, which provides food and services to underprivileged members of Indian society to enable them to attend elite institutions.
“mr probably is also incredibly generous giving away approximately two percent of his wealth every year to the dakshana for dao foundation the foundation provides food and services to some of the least privileged members of indian society which enables them to attend elite institutions of higher learning”
Warren Buffett's mentor Benjamin Graham taught him value investing principles, and later Charlie Munger influenced Buffett to buy better-quality businesses at higher valuations rather than just cigar-butt discounted stocks.
“he even even after he got influenced by charlie munger and he started buying better businesses”
Pabrai founded his consulting company Transtec in 1991 with 100K, sold it in 2000 for 20M, and founded his hedge fund in 1999 with 1M in assets under management; today the fund manages over 500M.
“in 1991 manish provides heard his own i.t consulting and systems integration company transtec with a hundred thousand dollars he went on to sell the company in 2000 for 20 million dollars in 1999 hedge fund for buy investment funds with 1 million dollars today has over 500 million dollars of assets under management”
Pabrai is a value investor who believes in finding extreme discounts and has successfully employed a value-oriented global investing approach for over 20 years.
“has successfully employed a market beating value-oriented global investing approach for over 20 years”
Business biographies and autobiographies are Pabrai's favorite reading genre; recommended titles include Sam Walton's autobiography, a book by Sol Price's son (on Price Club founder), Roger Lowenstein's 'Making of an American Capitalist' (Buffett biography), and Jeff Bezos's 'Invent and Wander' with introduction by Walter Isaacson.
“i mean i would say that uh founders you know i would say sam walton's book uh i think that's really good you know business biographies and business autobiographies is probably my favorite genre uh because i just love them so much”
John Alcán (Stellantis chairman) is a friend of Pabrai's whom he came to know well through Fiat Chrysler ownership; Pabrai views Stellantis as a good capital allocator with a young chairman and good team who should do well in the future.
“john alcan who's a chairman is a good friend of mine i i got him i got to know him quite well once i had a ownership stake in um in fiat chrysler and uh so anyway i think one of my deep regrets is that i used to um i used to own like more than one point three or one point four percent of fear chrysler”
Pabrai owned 1.3-1.4% of Fiat Chrysler (5B market cap, 70M invested) and received 1.3M shares of Ferrari in the spin-out (>1% ownership), but sold when trading at 30-40x earnings, generating 100M profit; if held, position would be worth 300M today.
“i used to own like more than one point three or one point four percent of fear chrysler when i first invested with a five billion market cap we put in about 70 million or so and then they spun out ferrari and uh you know i got 1.3 million shares of ferrari in that spin-out and again the my ownership of ferrari was over one percent amazing you know every hundredth ferraris sold was for the benefit of baby fund investors you know how utopian is that and uh and then in my infinite wisdom uh you know overly focused on the peo once ferrari is trading at like 30 40 times earnings i sold it so i think we made like 100 million on ferrari but if i had done nothing we would have like 300 million of ferrari stock today”
Pabrai read 'Zen and the Art of Motorcycle Maintenance' but found it difficult and did not extract the transformational value that Nick Sleep reports; however, the book became a bestseller after being rejected by 50+ publishers, demonstrating different receptors at different times.
“i did read uh zen and the art of motorcycle maintenance i also found it difficult to read and i could not get out of it what nick sleep got so nicely that particular book had transformational value for him in a number of different ways uh it did not have the same uh i mean i could i could i think towards the end of the book i started to understand more of it um but i think so i i would definitely say that it's it's worth it's worth picking up the book and reading it just you know just to see if it is something that resonates”
Pabrai had a long-running investment contest with Guy Spier comparing Sunteck Realty (PEO/special-situation focus) vs Mastercard (compounder focus); Mastercard is likely ahead, but Sunteck is 'just beginning to hit its stride' with improving capitalization and tailwinds.
“we haven't had an update in a while on the contest between you and guy spear of suntrek realty versus mastercard uh how are you feeling about your position and i know it's still in the early innings but what are you how are you feeling right now about that i think i think uh i haven't looked at the numbers lately but i would i would guess mastercard is probably ahead um i i have to go back and look at that but we also i think it's a long it's a long contest and uh uh sun tech is actually just beginning to kind of hit its stride right now”