OtherPleasure to be with all of you. What I'll do is I'm going to go through a brief monologue with a PowerPoint. Then we'll play a two and a half minute Bollywood video. And then we can talk about anything you want to talk about. Just, you know, skip asking me about the things that we own or might be buying presently and so on. But outside of that, anything is fine.
OtherArvind, do you have the first slide up?
OtherYou know, go BC. I'll go through a few slides. So, Arvind, can we go to the next slide?
OtherSo, are you all seeing Buffett's letter on the screen?
OtherOkay. All right. So, you know, this is not a doctored document. This is a real letter that Warren Buffett wrote to me in response to me applying for a job with him in 1999. And this was before Pabrai Fund started. And at the time, the only thing I had an interest in doing was to learn the art and science of value investing from him. And so I suggested to him that he could hire me at zero cost and such. And very quickly, within about five days of me mailing the letter, I had this response back from him, which I was pretty disappointed about at the time. And anyway, in a few weeks after that, I picked myself up with some help from my friends and decided to start Pabrai Funds. And, you know, we started with a million dollars, made eight investors, and I tried to set it up as closely as I could to the Buffett partnership. So let's go to the next slide. Just hit next. And so the question that comes up, you know, when you read that letter, is that, you know, why does Warren Buffett, who's got, you know, I don't know, 50, 60 billion of net worth, want to operate alone and with no analysts or associates? And then why does Charlie Munger want to do the same? And then there's a good friend of mine who's a value investor, Guy Spear. He operates the same way. In fact, he used to have an analyst till he figured out that that didn't make much sense. And it was actually, you know, kind of causing him to have results that were somewhat negative from what he wanted. And so he went from no analyst to analyst back to no analyst. And I think he's quite happy now. And of course, you know, I operate alone. And so the question comes up, you know, as to why I would want to do that. And let's go to the next slide, Arvind. And so, you know, the issue in the investment business is that there are more than 50,000 publicly traded stocks around the world. And even if you have a 10 person investment team,
Questioneryou know, very smart folks who are in the team, they cannot actually look at more than a few hundred companies as a group together in a year. In fact, they'll probably get to less than that number. And so if you're an investment manager with this 10 person team that you're working with, who's doing a lot of the research for you, you would basically get reduced to first of all, a lot of your time would go to manage the team, but also you'd be reduced to just getting a Cliffs Notes version of the research these folks were doing. And on top of that, you would have secondary data. So you would not really have a full data set the way the primary people are doing the research habit. So, and let's go to the next slide, Arvind. And so basically there's no way for an investment manager to be on top of thousands of businesses. That's just not possible with or without a team. And so really what the investment manager has to do, regardless of team size, is they have to take shortcuts because the data set is just too large. And the way they take shortcuts, there are many ways to take shortcuts. So, for example, there's a mutual fund, which is based in Minneapolis called the Mayors and Powers Fund. Some of you may have heard of it. And I think the charter of the Mayors and Powers Fund is to almost exclusively invest in companies based in Minneapolis. And so, you know, they've shrunken the universe of public companies to look at by having a mandate to only invest in Minnesota companies. There are other companies that will only invest in companies that are socially responsible. And certainly value investors take on all kinds of shortcuts. They might take shortcuts related to PEs or book values or, you know, cash flow multiples and those sorts of things to try to narrow the universe down. And, you know, there are, you know, Buffett says that it is not the size of the circle of competence that you have that determines how well you do as an investment manager. It is knowing the boundaries of that circle really well that are really important. And so, you know, you don't need to know a whole lot about too many things to do quite well as an investor. So there's a good friend of Charlie Munger's, who's, I think he is or was in the Forbes 400, John Arriaga, who lives near Stanford University. And all John does as an investor is he invests in real estate, which is, you know, within a couple of miles or less of Stanford University. So his circle of competence is extremely small,
Otheryou know, just real estate and just real estate around Stanford. And from a standing start justdoing that, he's a billionaire. And, of course, you know, Charlie Munger says that if you wantedto get really rich and have a well diversified portfolio, and you lived in, you know, Peoria,Illinois or something, what you could do is you could own part or all of the four dealershipsin Peoria. You could own the McDonald's franchise in Peoria. You could own the best apartmentbuilding in Peoria. And you could own the highest quality office building in Peoria. And if you hadjust those four assets, and if you just even own parts of those four assets, you don't need to ownthem 100%. But you could have, let's say, a 10% stake in the McDonald's, for example. And younever, you know, touch those assets, you just kept them. The odds are you would compound money atquite a spectacular rate and do quite well over time. And so the bottom line is that in theinvestment business, you don't need to know everything about everything to figure out whatare the best investments and such. And a large team is not as helpful as one might think to getyou to the promised land. And so let's go to the next slide, Arvind. And, you know, so one of thethings that happens is that when you have an analyst, you know, the chances are that you hiredthis person because you in some way like them as humans. And they are, you know, pleasant people tobe around and such. And they hopefully are smart, you know, BC grads and such. And so you know, whenthey come up with ideas, just the nature of the investment business is a lot of the idea that are great, you might think are not great. And so you'd say no. And you'll keep saying no most ofthe time. And sometimes you're saying no to ideas, which actually may be a good idea. Soany two humans are going to have differing circles of competence,because their life experience is different. And what they've learned aboutabout the world and different businesses and such is different.And so someone could come to you, your analyst could come to you with a great idea. And becauseit doesn't fit into your circle of competence, you might say, well, that doesn't work for me,we can't do that. And in fact, this has happened to me. So for example, in I think in 2006 or 2007,when just when the first iPhone had come out, I have a really smart investor in my fund, who's aventure capitalist in Silicon Valley. And he called me and he said, Monish, you know,
Todd Combsyou got to invest in Apple. And I told him very quickly that, you know, that's not happening,because you know, I don't do tech, I don't do businesses with rapid change, and so on. And thenhe laid out for me, you know, why Apple made all the sense in the world to invest. In fact, he,you know, he talked about the app store. And in fact, he laid out what was likely to happenin a manner that was eerie, because what unfolded over the next several years,was quite similar to what he had described to me in the sense that they would,you know, transform mobile, mobile technology, they would transformjust the way people, it wouldn't be a phone, it'd be a computer in your hand, andthe app store becomes a very high profit margin business for Apple with very little investment,and on and on. And of course, if I bought Apple at the time, I think it's probably a 10x fromwhen he was talking to me about it. And, but I was right to say no, because it was,it was indeed outside my circle of competence. And so if he were an analyst working for me,you know, he would be right in bringing the idea to me, I would be right in rejecting the idea.And, you know, he would rightfully be unhappy about it. And the same thing happened with,you know, Amazon. Some of my friends about 10 years ago, were pushing Amazon because they justsaw the way the company was transforming and everything. And again, it would have been amassive home run. And again, I said no. So circles of competence becomes one of the issueswith having a team size greater than one. Let's go to the next slide.
Todd CombsThen, you know, when you have a team, there's this natural bias for action, you know,like Warren says, guys are going to say swing, you bum, you know, why aren't you swimming,swinging. And, and if you have people who have high IQs, they're not really good at grinding awayendlessly, without seeing results. So you know, some smart analyst keeps coming up to you withgreat ideas, and you keep saying no. That's just a very difficult kind ofsituation to permanently be in. And just to give you kind of, you know, a real bit of datafor BriFunds, you know, in the last almost 17 months, we have had no new investment ideas,zero. And it's not because I haven't looked, I've looked for, I've spent lots of time looking forgood investment ideas and such, but we've never gotten to the point where something madeenough sense to pull the trigger. And so I just had to say no to myself.
Ted WeschlerBut you know, if I had analysts or partners, the natural institutional bias towards actionwould take over, you know, we, I think it'd be unlikely we would go through such a long periodwithout, without acting on ideas. And, you know, I've always thought kind of the bestway to set up the job description for an analyst is to hire them and give them the ground rules.And the ground rules will be something like this, that, look, I really don't want you tobe in the office pretty much at all. I would like you to, you know, pick a beach that youlike to hang out on or a ski hill that you like to, to be at, and you'll get your paycheck directdeposited into your account and just hang out at that beach or whatever activity you'd like to doand never ever call me with any investment ideas. And when I need help, you know, drilling down ona particular investment and need your brainpower, I will call you. So, you know, you need to keepyour cell phone around at all times. And when I call you, ideally you can call me back within 30minutes and drop what you're doing and go into full, full-time research and analysis mode on,you know, the, the help I'm asking for. And, and then when that's done, go back to theswimming or water skiing or skiing or whatever else you want to do. And again, you know, yourpaycheck's going to keep coming to your, to your bank direct deposit till I call you with the nexttime I need you. And you can see that this sort of a job description, even though it sounds exciting,may not be that appealing to even most of you in this room. And so, you know, it's, it's the,it's the difficulty in setting up a situation where a person isnot, not constantly feeding you ideas and you're constantly saying, no, that becomes kind of hard.And then, you know, the, the compensation problem comes also kind of a bit difficult.So someone brings me Amazon or Apple and in my, you know, moment of brilliance, I say noin 2007 or 2003, and then it's a 10 X or a hundred X and we missed that ride and no one made thatmoney. And so how do you compensate a person when things like that happen? And so can we go to thenext slide Arvind? And so, you know, one of the shortcuts I've taken, because again, the datasetis so large, is instead of being like John Arriaga and just doing Stanford real estate,I said, why not be a shameless cloner? You know, all I am is a low life cloner, which we'll soondiscover in all its glory. But basically, so long live the SEC and long live 13 Fs, which are the
Questionerquarterly filings that institutional investors have to make. So one of the shortcuts I use quite a bit is I look at what the other great investors are buying. And so, you know, if I make a list of, let's say 20 great investors, you know, Berkshire, Longleaf, Seth Klarman, Third Avenue, you know, David Einhorn and so on. You know, I have cut that universe of 50,000 stocks down to at the most a few dozen stocks. And if I especially look at what they bought in a given quarter, it might be down to, you know, maybe a dozen stocks or less. So it's really narrowed that huge universe down to a much more narrow universe. And clearly when people have made certain positions, that top holding or that top three holdings, some great mind has processed it and gone to the point of actually, you know, investing large sums into that position. And so then I can look at it and say, you know, do I want to do this or not? So if I see that, you know, Berkshire Hathaway has taken a position in Exxon, which they just did. You know, the good news is that Warren Buffett turned me down, but he doesn't realize that he's my analyst. And the best part is that he's my analyst at zero pay. And just like I told him, I told him, listen, just hang out in Omaha. And when I need you, I'll reach out to you. And usually I reach out to Warren on four days of the year, you know, on May 14th, August 14th, November 14th, and, you know, February 14th. Those are the four days when Warren tells me what he's been up to. And so, you know, I can then look at what he's been up to. And, you know, what's even great about Warren is I don't even have to do direct deposit paychecks or anything. And he's never called to complain. And the other thing that's really great about him is that I keep saying no to all these things he comes up with, and he never seems to mind. And it's just wonderful. And then the same applies to like Ted Wechsler, who's also in Omaha hanging out, just like I told him to, and Todd Coombs. And then, you know, Seth Garment hangs out in Boston with you guys, and so on, you know. And then we've got the Longleaf guys in Memphis. And all these guys are, you know, hanging out, doing exactly what I told them to do. And, you know, four times a year, they pop their head and just, you know, quietly tell me what they've been up to. And then they go away, you know, and they never get disappointed or dejected if I don't take them up. And in fact, as you can see, in the last 17 months,
Otherall these guys have come up with all sorts of things that I've said no to everything. Andamazingly, none of them ever mind. They're just fantastic humans.No emotional response to repeated rejections. It's fantastic. And so I have found that,you know, the payroll cost is zero, which is a nice number. I like that.And, you know, like the Miller commercial of some time back, you know,not only does it taste great, it's also less filling,you know, so it does both things at the same time. And let's go to the next slide.And, you know, besides Warren and Ted Wechsler and stuff, we have several other analysts andseveral other tools, mostly available at zero, close to zero cost, that are quite exciting andquite interesting for me to use and leverage. And so first, I'll start with, you know,some of these things that are coming up on the screen. Let's start with Value Investors Club.So how many of you in the room are familiar with Value Investors Club?Can we just maybe raise your hand? We have Arvind, I'm deeply disappointed inwhat you've taught them so far. How come you kept them away from the Value Investors Club?Oh, okay, sorry. Maybe I'm not seeing the full classroom. So anyway, you know, I don't know ifyou guys know the history of Value Investors Club. But you know, it was set up by Joel Greenblatt.And Joel and his partner, John Petri, basically, many years back, I think this is going backto the early days of the internet. They had done an analysis of some business that they were,you know, making an investment in. And I think they were on some Yahoo message boardrelated to that public company. And on that Yahoo message board, they saw one particular poster,put up a extremely detailed analysis of that business that they were looking at.And the analysis was actually superior to even what they had come up with. And this persondid not work at a hedge fund or a mutual fund. He was just an amateur investor investing forhis own account. And they were just really surprised that, you know, out in the Trans Am,if you will, was these, you know, islands of incredible talent. And so they thought about,well, how can we tap this talent? And so they came up with this idea of the Value Investors Club.And what they decided is that they would invite anyone on the planet who had an interestto become a member of the club. And to become a member, you had to submit an investment idea.And of course, they would review the idea and see if it was good enough to admit you into the club.
QuestionerAnd then once you got into the club, you were required to submit, I think, two ideas a year.And I don't think you could submit more than four ideas. So they wanted to limit how muchpeople could submit. And then every week they awarded $5,000 to the person who came up withthe best idea. And so, you know, they basically said that, you know, for about a quarter milliondollars plus the cost of running the website, they would get this amazing information flowand cut out all the nonsense that you get in Yahoo message boards, because they would basically,it's a basically curated site about what is posted or not. And actually, if you go on Value InvestorsClub, you will see in general that the average write-up is quite high quality. And many of thefolks who are posting write-ups and such are not professional investors. In fact, there's aperson who has a handle on Value Investors Club called Charlie479. So you can do a search onCharlie479. And, you know, it'll pull up all of the ideas that he submitted. I don't know if he'sbeen active lately, but his ideas were so good. So the other thing that Joe...Greenblatt and John Petri did was that if they were truly impressed with what peoplecame up with, then they talked to them and they set them up in the investment business.They basically seeded their money to manage, took a stake in the general partner and introducedthem to other people who might want to invest with them.And so I don't know the number, but I personally know of several funds that were set up bypeople who originally came on the Value Universal Club just as amateur investors, if you will.And so anytime I look at an investment idea, let's say, you know, in fact, like for example,last June, I noticed, in fact it was before that actually, it was in the first quarterof 2012 when the Berkshire 13F came out for the first time, they listed General Motorsas a holding of theirs.And of course, you know, I hated the car business, it's high capex, it's got unions, it's gotall these consumer taste vagaries and you have to make all these massive investmentsup front and such.And so for many reasons, I never had any interest in the car business and I immediately lookedat an idea that Berkshire bought and I rejected it.And then you know, when the second quarter of 2012, 13F came out, I noticed that GeneralMotors was also a top holding of David Einhorn's and I said, you know, why would David Einhorn
Questionerand Berkshire Hathaway both take these large takes in this pathetic company called GeneralMotors.And so I decided to do a drill down on the business and usually when I do a drill downon the first thing that I do, I look to see if that idea is posted on Value InvestorsClub.I'm not sure if I found anything there or not, but that's usually what I do is that'sthe first place I usually go after I just look at the Google Finance or something onthe company.And of course, I did a very thorough drill down on GM and it dawned on me that therewere a number of reasons why an investment in GM made all the sense in the world andthat led me to actually take a position in GM.And you know, we still own that position.I don't have much to say about it, except that you know, we are up I don't know morethan 100% to 120% so far on that position.So thank you Berkshire and thank you David.You know, you're just a fantastic analyst, I might have to send you a bonus or something.And so you know, Value Investors Club is fantastic.Sum Zero is something like that, it's another website where again it's a community of mostlyamateurs who are posting their best ideas.GuruFocus is another good website where they've created a list of gurus and again they'vegot all kinds of data on what their top holdings are, what they're buying, what they're sellingand so on.The manual of ideas is not free, I think it's about $900 a year or so.But I think it's exceptional.You know, $900 a year is a little less than what you might pay an analyst every year.And what the manual of ideas does is it makes my job even easier, so I don't even have togo through 13Fs every quarter.John Mielczarek, who is a good friend of mine now, who puts out the manual of ideas, basicallyputs out these very nice booklets with you know, a couple of pages on each fund if youwill and what they've been buying and what their top holdings are and all of that, ina much more easier to digest format than the 13F.You can get the same data through 13F, it just takes a little bit more work and time.So that's another great tool.There's a message board called the Corner of Berkshire and Fairfax, which is also exceptional.And again, when I look at, you know, when I find ideas to research, I look at ValueNurses Club, I also look at Corner of Berkshire and Fairfax.And of course Edgar Online is run by the SEC, you know.I pay them I think 10 bucks a month and that gives me access to all the findings in nice
Otherformats and such.There may be a way to get that stuff for free, but it just makes it a little bit easier.And then you know, there are various newsletters like the Graham and Dodwell, which is a newsletterfrom the students of Columbia Business School.And so these tools are actually quite valuable, and I think I found them very useful.In fact, if I look at our portfolio currently, I can think of only one stock that we ownthat is not a cloned position.That means it was not picked up from somewhere else.And so I should really call the fund the cloned fund, but let's try to keep this between usand let's not tell my investors about it.They might object to the outrageous fees I'm charging them.And so with that, why don't we do this Arvind, why don't we play that video.I hope you enjoyed my wonderful music selection.I adjusted my webcam so you can see the Charlie Munger bus behind me.Can you see that?We need to make sure Charlie is overseeing the proceedings here.Okay, so we can open up to questions.You know, you don't need to particularly talk about what you just heard.You can talk about anything.You can talk about anything you'd like to talk about.Okay, so let me just try to make sure I understood the question.So you're saying that, what do I do after I identify some stock through a 13F?Okay, so the research process you're saying.Yeah, okay.So basically the first question I asked myself is, you know, is this company within my circleof competence or not?That's the first question.And a lot of things are not within my circle of competence.So typically, you know, every time I look at Seth Klarman's 13F, you know, the BaupostFund, basically I see a lot of pharmaceutical companies on it.And I have no idea, you know, what they're all about or why those companies are evenon there.So, you know, they're a quick pass.So many, many businesses are like that where I cannot understand much about them, and such.So they are immediately excluded.Then you know, usually if a business has some interest, one of the first things I do isI look at the quick valuation metrics.You know, in general, the absolute lowest returns I'm looking for is it needs to beat least 50% off intrinsic value, so it needs to be at least half off.So there are many investors who will buy something for $13 if it's worth $18 or $19.And to me that's an automatic pass, because if I'm buying something for $13, I should
Todd Combsbe convinced that if not immediately, at least in the next couple of years, it's worthat least mid-20s.And so, valuation usually is one of the most common reasons for excluding something afterthe circle of competence.Now if we get past the circle of competence or something that I think I can understand,and also something appears to be somewhat cheap, then you know, the process I use isdesigned to basically get to a no as quickly as possible.So I will spend about a minute or two looking at the business, just looking at some metricsor quick data, to try to see a clear-cut reason to say no.If I don't get to that in the first couple of minutes, then I'll give it another 15 minutesand I'll go through a little bit more data, so I might open up the website of the business,look at an investor relation public presentation or something, you know, try to understandwhat the company is saying its prospects are and so on and so forth.And see if at the end of that 10 minute or 15 minute exercise, if it can safely be passedon for some good reasons.And if I cannot get to that point, then the next step would obviously be to start doinga little further drill down, you know, start printing off the annual reports, 10Qs, 10Ks,and I might spend a few hours looking at the business, again trying to understand why itwould be good and smart to reject it.And if I get past the next few hours and it's still not rejected, then I'll start doinga more thorough drill down and that might take a few days.And if it's still not rejected after that, then we'll run the checklist, see what kindof information that pops up, and usually the checklist brings up things that I don't knowabout the business, which is the biggest value it adds.And, you know, that might lead to more research and such, so it's a process of eliminationand eventually you hopefully get to the point where kind of seven ducks line up in a row,it looks like a good fit, and you can pull the trigger.Yeah, actually, I'm not too focused on, you know, rapid response or anything like that,you know, I think we've got plenty of time, and basically if I can find, you know, twoor three ideas in a year, I'm in good shape.And you know, I'll give you an example, GM is a good example of that.You know, the first time that was visible that Berkshire had bought it was, I don'tknow, like May 14th or May 15th or so, and of course I didn't do much with it at that
Todd Combspoint, and it's really a few weeks after that when I noticed that, you know, Einhorn also had a position that I started to drill down, and in fact, so that particular drill down, I actually must have read at least a dozen books on the auto business, different facets of the business. You know, I read books on Alan Mulally at Ford. I had read Sloan's book, you know, My Year as a GM some years back, and I re-read some parts of it. And then, you know, GM was a company which had a very rich data set. So there was a great book called Overhaul, which was written by Steve Ratner, who was appointed by the treasury to oversee the bailouts for the autos. And so, you know, basically between the filings of the company and a bunch of articles and books and such, I think that work may have taken a few weeks, maybe three or four weeks, and then we were ready to pull the trigger after that. There's no – you know, the thing is that the number one skill that you can bring to bear to beat the market is patience. So you know, you should never be in a hurry thinking that, oh, this talk might go up or, you know, I might lose this opportunity or whatever else. Actually GM became cheaper. I bought it at much lower prices than originally what Ted Wechsler at Berkshire paid for it. And so, yeah, so the, you know, one doesn't need to be under pressure that you have to act in some kind of rapid response manner or anything like that. Generally you have plenty of time to do that. Question is, how often do I come back and review the position? Well, so one of the things I do just before I pull the trigger is I'll write up a one paragraph thesis, usually no more than six or seven sentences of why it makes sense to make an investment in that business. And part of that six or seven sentences is what that business is worth, and why it's worth that. And so, you know, usually every quarter or every second quarter, you know, every three months or six months, I'll review some of the metrics that are coming out of the company to see how they line up with what I had assumed or thought might happen. And as long as things don't go in a straight line, as long as they generally line up and they don't seem to egregiously violate what we might have assumed, then you know, we might update the intrinsic value calculations every six months or something. But once the business gets to being worth around 90% of intrinsic value, it's a candidate for sale.
Todd CombsSo we know when we are going to sell before we buy.Not when, but we know under what circumstances we will be selling.And sometimes we might sell even before that, if you know, something gets to be a 75 or80 cent dollar, and something else shows up on the radar that's a 40 cent dollar and wedon't have cash, then we might make that switch.So those are some of the reasons that it might make sense.And you know, if I can add one more thing, you know, there were these two professors,I think one was at Ohio State, the other was at the University of Nevada, and they dida study of Berkshire Hathaway for 30 years, I think from the mid-70s to around 2005 or2006.And they said that, you know, what would be your returns if you bought what Warren Buffettbought after it was publicly known that he had bought the stock.And they made an assumption that you would buy the same stock on the last day of themonth that it was publicly known that he had bought that stock, and you found the worstbroker on the planet, and you paid the highest price that the stock traded at on the lastday of the month.And then you started selling that stock when it was publicly known that Buffett had startedselling.And again, you would sell on the last day of the month that it was publicly known thathe's selling.And again, you would look for the worst broker on the planet and sell at the lowest pricethat it traded on that last day.And these guys said, if you did this for 30 years, you beat the S&P by more than 11 percentagepoints a year.You know, so the S&P has done around 10% or so over a long time.You know, this would have done around 20-21% or something over that period.And you know, if an investment manager just beats the indices after fees, you know, theyare already in like top 15 or 20% of investment managers.If they beat the indices by just 3 percentage points a year, they are in the top 0.5% ofmanagers, the top 1 in 200 managers.When you are talking about outperformance of 11 percentage points a year over a periodlike 30 years, that is such an outlier that you would probably be amongst, you know, oneof the best managers out of thousands and thousands of managers.And with due respect, you wouldn't even need a BC degree.You know, in fact you could walk out of the class right now and set up the Berkshire clonefund which just does that.And in fact, every time I talk to students, I tell them this particular story.
OtherAnd I always wait for someone to, you know, first of all leave the classroom, but secondlystart a fund that does that.And after all these years, no one has left the classroom and no one has started sucha fund.And so that opportunity is still wide open.And so I just want to let you know, you know, this is not something that Arvind is goingto tell you.He is going to put your nose to the grindstone and make you do all kinds of analysis andstuff and it's all boring stuff.This is the real way you make money and such.And you know, you can hang out at the beach or on the ideal ski hill for 29 out of 30days.In fact, you can hang out for 30 days, you can just take a 15 minute break on the lastday just to check if Warren has done something or not.And you know, after you replicate what he's done, which would take you about five minuteson your Blackberry or iPhone, you can go back to your skiing.And lo and behold, you beat the index by 11%.And in fact, in many ways, what Pabrai Funds is doing is, you know, something similar.I haven't taken the rigor of just doing exactly what these professors said, but in effectI'm cherry picking what some great brains have already processed and said are what theythink are great ideas.And then, you know, just looking at the ones that I think, you know, pass my limited circleof competence and then take it from there.So let's take the next question.Okay, so I just want to make sure I got the question.So one is you said that I hadn't invested in 17 months and you were asking I guess whythat is.And the second is that something about cash, about you know, being in cash, I didn't getthat part.Well, all right, so let's handle the cash question first and in fact, that's a wonderfulquestion.So you know, in 2008 and 2009, I got my head handed to me in the markets.In fact, you know, the indices were down, you know, 38, 39%.I think in 2008, we were down close to like 67% or so.We were down a lot more than the market was down.And well, there's a couple of reasons.One of the reasons we were down that much is we were fully invested.We were caught very flat-footed.And of course, we've made up all of that ground and then some in the last few years, but Idid a lot of soul-searching as to why, you know, what went wrong in our process and suchand I made some adjustments.And so I said, you know, it's really important to have cash at times when markets are severely
Otherdistressed.
OtherYou know, anything that we invested in, in the fourth quarter of 2008.or the first quarter of 2009 is probably a 4X or 5X from those prices until now.Very significant returns were possible at that time.But of course I was not able to play offense because I didn't have cash to the extentI wanted to.So I said how do I ensure that when we hit these serious air pockets that we have theability to have cash.So first of all just some basic math.So let's say I have a fund that is 80% invested and 20% in cash.And let's say the market drops 50%.And let's just say that my holdings also mirror the market and they also drop 50%.Well what would happen is that my fund would drop from being worth, let's say it wasworth 100 million before, the 80 million in stocks would drop to 40 million.But the 20 million in cash would still be worth 20 million.So a 50% market drop would translate into a 40% market drop for me because of the cashpush.So the first thing a cash push is going to do is it's likely to cushion your drop tobe less in the market, which is useful.The second is that that 20% cash can now go on the offense and can get fully invested.And like I said in 2008-09 if we had that sort of cushion, there were lots and lotsof opportunities to get a 4X or 5X in a few years.So let's say you take that 20% and you invest it and you get a 4X return in a few years.So that 20 million becomes 80 million.The other 40 million might come back to 80 million or maybe even if it doesn't come back,let's say it ends up being worth 70 million.Well you now have a fund that's worth 150 million, you know, 50% above what it was beforethe crash.And on top of that your volatility and your drop would be less than the market drop.These are all good things.So what the 2008-09 period seared into me is the importance of a cash cushion.So the question was, how do you know when you should have a cushion and when you shouldbe fully invested.So the way I came up with taking care of that is I said, okay, if we have a brand new fund,let's say it's 100 million in cash.I said that the first 75 million can get invested in ideas that are 2-3X in 2-3 years.You know, a double in 2-3 years is fine.Then the next 10%, so the first 75% goes invested in 2-3X, the next 10% we need at least a 3X.So that would get you to 85%.And then the next 5% I said should have at least 4X return possibilities.So that would get you to 90%.
OtherThe last 10% is 5X or more.
QuestionerOkay.
OtherSo basically, if I looked at my fund for most of the last 17 months, we were sitting on about 10% cash for most of this period. And so the bar was that it could get invested if we found opportunities, which were a 5X or better in 2-3 years with relatively muted downside. And that's a high bar. It's not easy to find 5Xs. In fact, my purpose of having this talk with you today is to impress upon you that you were put on this earth to send me those 5Xs. And so Arvind will give you my email address, but it's also at the end of that video. And so when you have those 5X ideas, after you have fully satisfied your own appetite, you can send it to me and that'd be much appreciated. And so basically what that first 75% 2X, then 3X and 4X and 5X does is it acts like a circuit breaker. It prohibits me from basically getting fully invested unless either markets get distressed or some very compelling ideas show up. And so, you know, we've been floating around for the last year and a half or so with that cash cushion. And in fact, I see nothing wrong with that 10% or 15% cash cushion, even 20% cash cushion being almost permanent. You know, that's perfectly fine. I think that the idea that markets would go through dislocations is almost 100%. We will see plenty of dislocations. You will see several dislocations in your lifetime. And so the dislocations will happen. We don't know when they'll happen. And quite frankly, to get fully invested, you don't even need dislocations. You might get fully invested with some anomaly with particular businesses and particular industries going through temporary distress and that's perfectly fine too. So that's the reason why we found a lot of 2Xs and even 3Xs, but they've got enough to you know, pull the trigger if you will. And so that's why we're sitting with the cushion we're sitting with.
QuestionerYeah, that's a good question.
OtherSo, you know, we aren't really fixed income investors. Like I mentioned, the lowest bar is looking for 2X. But sometimes we found businesses where the bonds were sitting at, you know, 50 cents on the dollar or 30 cents on the dollar. So obviously, if you invest in the bonds, you're going to be higher on the capital structure. And to some extent, it's a little bit easier to make those investments if you have high conviction that the business is going through temporary distress and those bonds are likely to get to par in some reasonable timeframe.
Todd CombsSo in that case, you know, the equity might give you even more returns.You know, sometimes when you have bonds at 40 cents, by the time they get to par, theequity might be a 5X.But the risk profile is much more muted with the bonds.And so sometimes we've opted to buy distress bonds and gone that way and it's worked outokay.It's just a proxy for equities.Usually, when I've done that, I've picked one or the other, and especially if I'm convincedthat the equity is above zero, almost for sure, then of course the bonds are worth par.And so, you know, I think that, you know, the thing that Buffett says, rule number one,don't lose money.Rule number two, don't forget rule number one.I think the most important thing in investing is, besides the patience, is to really, reallyfocus on the downside.If you truly spend plenty of time thinking about what can go wrong, the upside will takecare of itself.But you really want to spend a lot of time on what could go wrong and what could causethe business to suffer and such.So downside, spending time on the downside is a good, good thing.
QuestionerYeah, that's a question.A good question.
Todd CombsI used to basically, I think until 2008, if I made a bet, it was typically at 10% of assets.And typically, you know, the top 10 or 12 positions would make up at least 80% of assets.In 2008 and 2009, when we were seeing these massive drawdowns, I was also seeing lotsand lots of opportunities in particular sectors and not enough time to really drill down andunderstand each business, even understand which one was the best.So for example, you know, many different commodity businesses have collapsed in late 2008.And you know, for a number of reasons, many of them looked great to invest in.So what I did is I made a basket bet.So I invested in each of these businesses at 2% of assets, and we made up a number ofdifferent commodity type bets.And in fact, we had no losers, every single one of them was a multi-bagger.And that worked out well.So what I did is after the 2008-2009 timeframe, I basically came up with three thresholds.An investment could be at 2% of assets or 5% of assets or up to 10% of assets.And typically 2% would be something which is, you know, either got kind of asymmetricrisk reward possibility, but the risk is somewhat elevated.It's not as muted as we'd like, but the rewards are, you know, outlier rewards, if you will.I mean, like we exited that position, but we had taken a position in Freddie and Fannie
Questionerpreferreds.And a number of different investors have recently taken those positions and such.And you know, those preferreds by Freddie and Fannie got knocked down 95%, even moreat the bottom, I think they were down 97-98% from PAR.So very significant.So if they went to PAR and you were buying at the absolute bottom tick, in some casesyou had a 40-50X return possibility.And of course, I didn't get in at those prices, but we were buying in the still single digits,you know, 7-8-9% of PAR.And of course, in the end, we exited the position, we exited at a slight loss because we hadother opportunities that looked more interesting at the time and I wasn't fully, and I'm stillnot fully convinced on whether that will work out or not.But the thing is, those preferreds actually have moved up quite a bit since then.And in fact, you know, recently Bruce Berkowitz was talking about making some audacious proposalto the US Treasury that he and some fellow investors would take over Freddie and Fannie'spart of their business and, you know, those preferreds would go to PAR as part of thatpackage.So that was an example of something that, if we took a 2% position on that, we wouldnot have done more than that because it just had a bunch of hairy net incomes possibility,but also had huge rewards as well.So 2%, it could be the basket or something unusual, 5% might be some normal type opportunityand 10% if you're, you know, quite convinced about the prospects and such.I think you need to be, if you are in the investment business, then, you know, it helpsto be a curious person.It helps to be a person who's a voracious reader and it helps to be a person who's veryinterested in businesses in general and very curious about how different businesses runand make money and all of that.And if those types of traits are present in you, then by definition, your circle is goingto expand over time.But I don't think you need to particularly focus efforts towards expanding the circle.It will happen naturally, but also it's important to remember that we have the genres of theworld who have a single asset class.That's all they've invested in and they've done extremely well with that.So it's really, of course it's useful to have larger circles, but it's not that important.And I think that this is a business where you're better off being an inch wide and amile deep versus a mile wide and an inch deep.So if you start off being an inch wide and 200 feet deep, then, you know, I would say
Questionerput more energy behind going deeper versus going wider first.
Todd CombsWell, I think it depends on the business, but in general, it's a function of the growth. So growth and stability of cash flows enter into that equation. But if you have a business that has, let's say, absolutely zero growth, it's just going to sit at the same level of cash flows. But it has very high stability on those cash flows, kind of like a utility and almost guaranteed to come in. Then, you know, I would say a business like that is worth at least 10%, I mean, at least 10 times cash flow. You might go a little bit higher in a very low interest rate, and by making 12 or 13 or even 14 times. So I would say that a business like that is worth, let's say 10 to 14 times cash flow. And so if you can get it at, you know, five or six times cash flow, the odds are good that you'll get a double out of it. If you get a business that has stability of cash flows, but the odds are high that they might grow up at some, you know, small rate, let's say five to 10% a year, then that's worth quite a bit more, you know, that'd be at least 15 times in my book. And sometimes you get to businesses, like, you know, one of the stocks in my portfolio right now is a company called Horsehead, you know, the ticker symbol is Zinc. And you know, I'm not saying this to, you know, talk about the business, but they have kind of two facets to their cash flows. One facet of their cash flows is somewhat independent of the price of Zinc. So if Zinc prices stay where they are today, which is pretty low right now, you know, these guys may produce somewhere between 130 to 170 million in cash per year from that business, if Zinc prices stay where they are. And that might start coming up in a year or two after they finish some investments that they're finishing off. And so it's a company that has a market cap of 700 million. And so, you know, on the low end, if you look at their low hundreds type cash flow, let's say 120 million or something or 130 million, it's at like six times cash flow or something. But you know, Zinc prices could collapse like they did, in which case cash flows would go down. But also the flip side is that for every 10 cent increase in the price per pound of Zinc, their cash flows increased by 25 million. So they're very highly levered to the price of Zinc. So Zinc is, for example, currently at about 85 cents a pound. And the historic range, the last few years, the historic range on Zinc is like 50 cents
Otherto two dollars, for example.And 50 cents is the price when the world shuts down, kind of like financial crisis when noone is using anything.So that's kind of unlikely.I think it's unlikely to go below where it is right now.But it's not outside the realm that in the next few years, Zinc prices might be a dollar30 or a dollar 50 or even two dollars.That could happen.And so you have this kind of low end, you can say 120, 130 million of cash flow andextreme high end, you have like 280 million of cash flow, right.So what's a business like that worth?Well, you know, I don't know what it's worth, but I think it's worth more than what it'ssitting at right now.And so you would look at those sorts of – in effect, what a business like Zinc is givingyou is giving you a free option.You know, I'm not paying for those Zinc prices going to a dollar 50 or a dollar 30 or whatever.If that were to happen, almost for sure that stock would move in a very significant way.And so, you know, I like free options where you have upside without downside.So I think it depends.I think when you're looking at these cash flows and such, you know, how stable are they?How variable are they?And in fact, in businesses which have high variability of cash flows, you can get widergyrations from intrinsic value, which creates the opportunity to do something with it.Yeah, I mean, I think, you know, when I made the checklist, the biggest number of questionson the checklist related to leverage, which means that the most failures that most peoplehad in their investments was because something went wrong with leverage.And so I think that in general, I think you need to pay a lot of attention to how businessesare financed and how conservative they are on their financing.And so I think that in my case, what would happen is that the checklist would throw upall sorts of red flags in the case of a business that's highly levered.So you know, what matters is, you know, with leverage, is it recourse, is it non-recourse,is it at the plant level or corporate level?You know, how stable are the cash flows versus the leverage?What kind of multiples do you have on those cash flows versus your interest payments andall that?So all those things I think matter.I think being a good credit analyst is a huge advantage.So yes, I mean, I think you need to pay attention.And ideally, you want to look for businesses which generate large cash flows with virtually
Otherno leverage.
OtherYeah, so actually just to take a step back on the checklist, one of the things I did not want to do with the checklist was to just blue sky think about things that are good to think about as an investor when you're making an investment. I did not want to create a checklist in that way. What I wanted to do with the checklist was to create it based on real losses that some great investor had, because they missed something elementary. And so every investor, no matter how good they are, plenty of mistakes they're going to make. In fact, John Templeton says that if you're right two out of three times in the investing business, you're going to hit the ball way, way, way out of the park. So the good news of this business is you can have a very healthy error rate and still do quite well. So that's one thing to keep in mind. And so what I had done when we were creating the checklist was to look at permanent losses of capital that had occurred amongst investors that I had a great deal of respect for, and then try to reverse engineer why those losses might have occurred. And the easiest ones to do on that front were Buffett and Charlie Munger, because they talk so much about their mistakes. And many of the investors don't talk about their mistakes at all, and some fall in the middle. So in some cases I had to kind of reverse engineer what I thought the mistake may have been. But in other cases like with Berkshire, you know when I looked at Dexter Shoes or US Air or them buying Berkshire Mills and all these different investments they made or NetJets for example, the nature of the mistake was obvious and therefore coming up with a checklist question was easy. Some of the other ones took a little bit more work, but we were able to get there. You know like before the financial crisis, Longleaf Partners had invested in General Motors, and of course eventually GM went bankrupt and of course they lost a lot of money on that investment. And ironically now I have an investment in GM, but it's not your father's GM anymore. So you know, we looked at – I had an intern who helped me do that, and so the checklist questions came out of real failures that I had in investments that had gone south for bribe funds and other great investors had. And so we end up with a list of 90 odd questions. So I wasn't particularly planning that the checklist should go in one direction or the other. It was really driven by the mistakes and what those questions were.
QuestionerAnd then when I re-categorized, I reordered the checklist by category.What surprised me is that how beautifully they fell into a few different categories.So there is a significant number of questions, I think more than 20 plus questions, maybe25 questions, which relate to various types of leverage and failures related to leveragethings.Then there is another section that relates to modes and competitive advantage, you knowshrinking modes or non-existent modes or you know, mistakes made in thinking aboutthe mode and such.There are a lot of questions around that.You know like Dexter's shoes in Berkshire's case was worn by a mistake about that mode.Then there is another section that is on management and ownership.You know, what percent of the company does management own, how they compensate it, howaligned are their interests.So all these questions related to management and ownership.And then we get to some miscellaneous areas like, you know, unions, organized labor, environmentalissues and things like that.But the top three or four categories basically took up most of those questions.And those are the most important things you would think about, you know, you would thinkabout leverage, you definitely would spend a lot of time thinking about moats and competitiveadvantage.And you definitely want to spend a lot of time thinking about the folks who are runningthe show.And you know what, what types of people in history and such that they had.And so to me, it was surprising how the most of the mistakes were in those areas.
QuestionerYeah, I mean, I think the question I try to ask myself is that, was it obvious beforethe investment was made, that this was a possible failure point, and a significant failure point,and not something obscure, just, you know, headlights front and center.And, you know, so like, you know, if you look at Dexter Shoes, you know, can the businessbe decimated by cheap foreign competition?You know, that's a question on the checklist.You know, when I looked at Longleaf Partners and the investment in GM, you know, they hada lot of commentary when they own the stock at a time when they're bullish on the stock.And they were bullish because, you know, the big three automakers in the US dominateda truck business.And they still do.They dominated it at a time when Longleaf owned it and they still dominate it.In fact, they dominated it in a very incredible way.And those trucks actually are just cash cows, you know, I think that these guys are making
Todd Combsa $10,000 a truck.It's very high profit margins on those trucks.And so that's a great franchise and, you know, Longleaf focused on the power of the franchise.And they were right.You know, the trucks have a great franchise, but, you know, there's other layers in thatbusiness.The unions, the labor relations, the high capex nature, and those should have been majorred flags.You know, and of course, one of the things that happened with GM post-bankruptcy is thatDetroit used to be one of the worst places on the planet to build a car in, let's say,2003 to 2007, for example.You know, very high labor costs and all these very highly inflexible labor.In fact, labor was not a variable input into manufacturing in US autos.It was a fixed cost.So if GM and Ford did not need a worker, the UAW contracts required them to pay them fullpay while they sat at home.And full pay was, you know, with benefits approaching $60, $70 an hour.So you know, how do you compete against people who are making $5 a day with those sorts oflabor costs?And so, you know, in the case of Longleaf, to me, it was obvious that the main thingyou should have focused on there, or they should have focused on there, would have beenthe issues related to labor and capital intensity and such.And of course, then the big three had other problems with quality and other things withtheir non-truck offerings.So these are, and you know, I don't want to beat up on Longleaf, I'm just using that asan example.They are exceptional investors.But these are just some examples that stood out.And in many, many cases when investors made mistakes, we couldn't tell, I couldn't tellwhat the failure point was.So we, you know, just like when Ball Post makes an investment in some pharmaceuticalcompany, I can't figure out why.And so if they lose money, I also can't figure out why.You know, and that's fine.You don't need to know all of them.But we were doing the checklist.We needed to just understand enough to build a decent list.That's a very good question.In fact, I did not understand that much about commodity-based businesses till late 2008.And it dawned on me at that time when I was looking at some of these businesses that commodity-basedbusinesses can have incredible moats.In order for them to have incredible moats, they need to be low-cost producers.So most commodities, you know, they talk about which quartile of cost they are in.So, you know, the bottom – so let's take not the company with the ticker symbol zinc,
Warrenbut let's take the commodity zinc for example.So if you look at the commodity zinc, the lowest cost producers in the world who havethe lowest cost mines, the bottom 25% of production may have a cost of let's say 40 or 50 centsa pound.The next quartile, which is the 25 to 50% producers, may have a cost of production oflet's say 60 to 70 cents a pound.Then the third quartile you might get to 70 to 80 cents a pound, and the fourth quartileyou might get to maybe close to 90 cents a pound, 85 to 90 cents a pound.So if your trade, if zinc is trading like it's trading right now at about 85 centsa pound, and of course there are zinc producers who have a cost of a dollar a pound, thereare zinc producers who have a cost of $1.25 a pound, $1.50 a pound, you know, it justgoes on.You can have parts of the earth where you can produce zinc, but it's very expensive.And of course, so all those guys who have costs above 80, 90 cents a pound, unless theirmarginal cost of producing zinc are very low, they pretty much have shut down productionat present prices.They're not able to produce because they would lose money on every pound they produce.So those mines are mothballed, if you will.And so if zinc demand increases, you know, the price might go up to $1 or $1.05 or $1.10a pound, and more production may come online.The person who has the greatest moat in that business is that mine that's producing at40 or 50 cents a pound.So that mine is going to make money day in and day out.They're going to make money no matter pretty much what the state of the world economy is.Because you know, even if production drops, even if China goes into a tailspin, all kindsof things happen, it's still unlikely you get to less than 50 cents a pound.And so if you own a commodity business where you are the low cost producer, and you havesome pretty significant volumes you can bring on at a low cost, that is a fantastic business.That is a business that has as much of a moat as Coca-Cola has, or Geico has, for example.It is an enduring, durable, competitive advantage.And so when I look at commodity businesses, one of the first things I look for is whatquartile are they in, in their production.And if they are generally speaking, and of course you also have to look at long continuumsof where commodity prices are.So like for example in 2008 when we were making these commodity investments, most of the investments
Greg Abelwe made were in businesses that were first quartile producers.And in fact prices had come down to the point where they were barely making money.But it was clear to me that at some point the economies would start functioning again.The world would go from a completely stalled economy situation to a working economy globally.And as soon as you got to a working economy globally, those prices would rise.And then these low cost producers would go from making very little money to making gobsof money.And of course when they got to making very little money, their stock prices absolutelycollapsed.I mean they collapsed to the point where there was a company called Techcominco in Canada.A blue chip miner, they are like the IBM of mining.Their stock price went from $50 to $4 in about four months, because they had some specificdynamics of leverage that was causing stress for them.But also commodity prices had come down.But they had some of the lowest cost mines in the world, and so they had incredible assets.And in fact, so we invested at those $4 or $5 prices, and eventually the business wentup to $40 and $50 in not that long a period.And so yes, I think that when we were talking about expanding circular competence, I didnot understand commodities very well before 2008.I got a lot better understanding, and I do feel that I've got some, let's say tools inmy arsenal now which help me understand commodity businesses, which I didn't in 2003 or 2005.So that is somewhat helpful in the future.And such, the same with when I studied these autos like GM and such, I understood somedynamics about the auto business that I never understood before, which again gave me some,hopefully will give me some advantage over time.It's a good question.Actually, when you're looking at commodity businesses, then I think you have to understandcost curves.You have to understand where they are on the cost curve.You have to have some understanding of kind of what are normalized commodity prices andsome commodity prices under different scenarios.So I think you have to understand those facets of macro, but you don't need to understanda whole lot beyond that.I mean, I think that, you know, in my investment in zinc, for example, I understand cost curveswell and I have some understanding of what drives zinc prices and such, but I don't havea very good understanding of that.So I think that there is a decent chance in the next few years that we might get significant
Warrenmovement upwards in zinc prices.But the thesis doesn't rest on that.You know, if that happens, we will make out quite well.But I think our investment probably works out even if that doesn't happen.And so that was fine.The more you're depending on a rise in prices, the better your understanding needs to beon why that is absolutely assured to happen.What was the question that, thoughts on shorting and why I don't short?Well, you know, it's a stupid bet because and maybe Bill Ackman can educate you on whyit's a stupid bet, but the maximum upside is a double and your maximum downside is bankruptcy.And, you know, Charlie Munger has a saying, he says that, I don't want to go back togo, you know, in the game Monopoly, I don't want to go back to go.He says, I've been at go at one time in my life.I know what that feels like and I don't want to go back there again.So, you know, if you're doing a straight short, then there is no limit to how high stock pricescan go. And eventually you may be right.In fact, both Buffett and Munger say that they've many times identified great shortcandidates. And of course, they've never pulled the trigger, but they said that they werealmost always wrong on the timing if they had gone ahead and done it, because you maybe right, you may eventually be right.But in the meanwhile, you know, you may have to withdraw the bet and not get to play yourhand out or you can flat out be wrong.I mean, the thing is that the average business and the average CEO and employees and allof that who go to work, they go to work to add value.They don't go to work to help the short seller and subtract value every day.So you have many forces working against you.And so sometimes, you know, you can get irrational pricing, exuberant pricing.You know, you might say that Twitter has a ridiculous price.Many of these dot coms that have gone public have ridiculous prices.But you know, they can get much more ridiculous before they get to valuations that you andI might consider sane.And when they go from ridiculous to more ridiculous and you are short, that is a verypainful experience.The other thing is that once you short a stock, you have an umbilical cord link to a courtmachine that cannot be broken while markets are open.So you constantly have to look at what a stock is doing.And you know, I am usually drooling on my pillow till almost half the trading day isdone in the morning. And so shorting just wouldn't work very well for me because, you
Otherknow, by the time I rise to my slumber, you know, all hell would have broken loose.So it just doesn't work for me.And why short when it's so easy to make money on the long side, especially by being ashameless cloner?OK, yeah, that's a good question.So the first thing I would do is to start creating what can be an auditable trackrecord. So what you what you need to start doing, if you're not already doing this, isset up a separate brokerage account.Hopefully one from where you're not writing checks for your groceries and such, and itdoesn't matter what amount you put in, you know, you could have five thousand or tenthousand dollars in that account, for example.And you trade on that account the way you would trade a million dollar or a hundredmillion dollar portfolio, for example.And you see, it'll give you a couple of data points.One is, so don't do this on paper.It needs to be real money, real broker.And the first thing is you will yourself get data on how good an investor you are.So after a few years, after three years or five years or seven years, you will knowwhether you are meaningfully better than most investors or not, because the data willstart pointing in a particular direction.And also you learn a lot, which is great.And that can go on while you have another day job and such.So you can start you can start building that today while you're a student and such.The second thing that you can do is to the extent that it doesn't have a conflict withyour employer and you've got some years that you spent investing your own money anddone well with it, then what you can do is you can go to friends, family and fools andespecially the fools.They are the most important.And try to convince them to give you some money to manage.And, you know, start building now a record with more than just your own money.And you can do both of these things when you have a day job, as long as your day job isnot managing money or if your employer doesn't object to these types of activities.And, you know, over time, if you do well.So, you know, like I said, even small outperformance was the market is pretty rare on along term basis.So if you are outperforming the market by 3 percent or 5 percent or any numbers likethat, you know, Buffett says that you can be in the middle of the Atlantic and potentialinvestors will swim to you in shark infested waters in the middle of the Atlantic toinvest with you if you are doing well as an investor.
QuestionerSo if you do well, then your existing investors are likely to give you more money tomanage and they're likely to introduce you to other people and such that they know.And so the assets and the management will probably grow.
OtherYeah, that's a good question.
OtherSo usually I'm expecting the convergence to intrinsic value to happen over two or threeyears. You know, I feel that you should you should be patient and give it at least thatmuch time. It can get to convergence a lot faster, can get there in a year, which isgreat. But, you know, two or three years is fine.
We've had positions, I mean, Pobrai Funds has about a 15 year, almost 14 and a halfyear history now. I think there's been a few times that we've had positions for.
Five years or five or six or seven years, I think that's probably the, but not thatoften. It happened once in a while.
I mean, our position in Horsehead is about five years old now.
For example.
When it gets to 90 percent of intrinsic value or if it's below 90, maybe by 80 or 70percent or something and something else is much cheaper, maybe a 40 cent or 50 centdollar, you might and you don't have cash, you might make that swap.
I also want to as much as possible for our US funds have long term gains.
So in general, we don't, you know, not a big fan of selling less than a year and suchunless, you know, it's getting well above intrinsic value and all of that.
Right. So, you know, I think that if we have things that are in maybe four or fivedifferent buckets, that's a decent number.
So, you know, if we had, let's say a, you know, a couple of positions which are in thesame industry, we don't have a problem with that.
So I'm not looking to have, you know, 15 different industries that we invested in atall times. If we find that, that's fine.
But, you know, it can be four or five different industries.
Yeah, let me just think of a few recent ones, there's a book that just came outrecently, it's called The Frackers and I think it's a New York Times columnist, GregZuckerberg, I think, is the author and it's, you know, it's basically tracking the wholefracking and horizontal drilling industries, those have some very significanttransformational impacts for decades for the United States and probably for othercountries in the world as well.
So I think it's just a good book to understand and it's playing out in front of us, youknow, in the sense that just as recently as five or six years back, you know, almost
Warreneveryone was very concerned about becoming energy independent and huge dependencies onMiddle Eastern oil and all of that.And I think the United States is well on its way to basically fairly quickly becominga net exporter of energy.So that's an important development.There's another book, which is in a completely unrelated vein, which I liked a lot.It's called Give and Take.And I think the name of the author is Adam Grant, I think that's what his name is.And that's an interesting book, you know, he divides the world into three types of people.People who are givers, who are takers and who are matchers, you know, matchers are peoplelike, you know, if I do something for you or if you do something for me, I'll do somethingsomewhat similar to you.And he just shows the kind of the amazing returns the givers get, you know, people whoare doing all sorts of things for all kinds of people without trying to keep score.And I think that's another great book.So so these are some books I enjoyed recently.And there might be some others, I'll think about some others that might you might findinteresting.
QuestionerYeah, you know, actually, I don't I don't read, you know, people think I read a lot.I don't really read that much.Sometimes when I find a book that's really interesting, then I like to pound throughit. I would I would guess that I'm probably reading, I don't know, 50, 60 books a year.My guess is that book a week type thing is my guess.And one of the things I do is I don't hesitate to abandon books.Most books could be summarized into five pages.And and I'm deeply disappointed that these authors don't do that.And so, you know, many times you're going to the book and you're trying to find nuggets.So, you know, many times you're going to the book and you're trying to find nuggets.And, you know, if I'm 40 pages into it and I can't really try to figure out where thenugget is, I might give up, you know, and because there's an opportunity cost.And then, you know, I have good close friends who will never, ever abandon a book tillit's finished, no matter how useless it is.And so you have people in full range of spectrum on that front.But my take is that, you know, if it's not somehow, you know, grabbing me or deliveringvalue in the first 40, 50 pages and it continues to do that, then it's probably going tolose me.
QuestionerYeah, I basically just cloned that from Warren and Charlie.So, you know, and it's a subset of what they do.
Todd CombsSo I think they would be a better reference for you.But I subscribe to three newspapers, daily newspapers, New York Times, Wall Street Journaland Financial Times.So I read those three newspapers every day.Then I subscribe to a bunch of magazines and you know they are like Forbes, Fortune, BusinessWeek and The Economist for example, so these are like four magazines that are showing up.Then we have subscriptions like the Manual of Ideas and I have a subscription to OutstandingInvestor's Digest, but I haven't seen an issue in I don't know how many years, so I thinkit's been a couple of years since I saw an issue, but I would love to read that whenthat shows up.And then beyond that there are the books that I'm reading and then you know the investmentresearch that is coming up and such.So that's I think that's much of the reading is in that sphere.Yeah no I mean I think okay so our Japanese investment idea, first of all that was oneof my non-cloned ideas.It was actually an original thought, God forbid, which came from my brain and it did not work.So it reinforced for me not to come up with my own ideas because they all suck royally.So the Japanese basket I think we ended up with like a two and a half percent returnand it took a lot of work to buy all those different names and then sell all those differentnames.And so the good news was we didn't lose money, we didn't make money and as long as we don'tlose money I think I'm fairly happy.So we were in and out with slightly above money market returns, so that was okay.Yeah I mean I think my preference is not to do these baskets and things like that, it'sto really hone in on a particular business and understand the dynamics of the businessand you know different competitors in the industry and pick the one that I think hasthe best prospects in terms of returns and such.And so I think the baskets have been kind of few and far between in our history.They are mostly anomalies and you know, really want to focus much more on – I think sometimeswe get to the point where we get some aha moments, like in 2008 with commodities theaha moment was that cost curves matter and there were a whole bunch of first quartercost curve companies available at throwaway prices.So I said okay, we can just go into all of them and that worked.The second aha moment was that Japan was you know, the net capital of the world and allthese cheap below cash companies and that aha moment didn't work, you know because
Questionerthe only way I could really invest in those businesses because I couldn't understandthem, most of the filing were in Japanese and so on, was to just do a basket the wayBen Graham did a basket.
And that didn't work and one of the reasons that it didn't work is that what Grahamsays is that the ideal time to buy these net nets is not when the markets are really cheapor when markets are really expensive.
And he said that markets are really cheap if you buy net nets, the good businesses willend up doing a lot better versus these cheap net nets.
And when I bought the net net basket in Japan, the Japanese market was at a multi-decadelow and so it did rally, the market did rally but our stocks really didn't move that much.
So if I had actually held a basket of Japanese blue chips instead of the net nets which wouldhave been more expensive, I would have had fantastic returns.
And of course, I probably would never have paid up for those and bought that sort ofbasket so that wouldn't have happened.
QuestionerYeah, so that's a good question and you know, before I was in the IT industry, when I wasgrowing up, my father was an entrepreneur and he was kind of an entrepreneur on steroidsin the sense that he must have started, bankrupted, sold and grown at least 15 differentbusinesses and 15 different industries over his career.
And the common theme in all his businesses was that they all started with pretty muchzero capital.
He was bankrupt, personally bankrupt many times in his life and many times I saw himrestart with nothing in completely new industries.
And of course from the age of like 13 or so, my brother and I were like his de factoboard of directors.
So he didn't have anyone else to talk to, but when these businesses were in serioustrouble, he used to sit down with us with the numbers and we would try to figure outhow to get past the next day, how to keep the business alive for one more day.
And then we'd get past the one day and again sit down in the evening to try to figure outhow to get past one more day.
And after I was about 16 or 17 years old, many times when he traveled, my brother andI used to actually run the operation and such.
So I felt like, I didn't realize at the time, but later when I started working, I realizedthat I had finished many MBAs before I was 18.
And it was just by accident, that's the way it happened.
And so today when I'm running the funds and doing what I do, I think the experience I
Otherhad in my teenage years was probably the most important in terms of giving me the skillsthat I use in the business today.
And in fact, the human brain actually is ideally set up to specialize during our teenage years.
It is actually optimized to go into a particular field from the age of like 13 or 14 to about18 or 19.
And of course what happens in the way education systems in the US and almost anywhere elsein the world are set up is in that age band, we are forced to become generalists.
You know, the education system does not encourage specialization during that period.
And when you look at some humans like Bill Gates or Warren Buffett, you know Warren Buffettbought his first stock when he was 11 and he had run a number of different businessesas a teenager.
Pretty significant size businesses, and by the time he was 18 or 19 he had made all thesestock investments, run all these businesses and probably spent more than 10 or 15,000hours on them.
And the same with Bill Gates, you know he used to sneak out of his parents home at nightwhen he was in high school, and he would go to the one computer in the high schoolthat he was in, Lakeside, and he would work on it until about 5 in the morning.
And then he would sneak back into bed and you know, go back to school the next day.
And he did that through his teen years.
And of course by the time Gates was 19 or 20, he probably had you know 15,000 hoursof programming experience, which hardly anyone who was even 10 years older than him had atthat time.
And so the thing is that it was not only the number of hours of experience that the Gatesand Buffett's and Leonardo da Vinci or Michelangelo and all these guys had at that time, it'sthat that intense activity took place during that window of time when the brain is specializing.
And so if you try to do the same thing in your 20s or 30s, the brain is past the timethat it is optimized to specialize.
And so one of the things I think, and in fact you know one of the interesting things I feelis that when you look at the country like Germany, you know it's interesting that Germanydoes really well even in manufacturing when it has one of the highest labor costs on theplanet.
And the reason is that the German school system starts segregating kids into different trackswhen they're like 11 or 12 years old.
And so if you're going to go into a track which is going to be manufacturing, vocationaland that sort of thing, then you will besides going to school, you will start working in
Othera factory at the age of 13 or 14.And if you're going to be going on to become a mathematician or something, then you'regoing to be you know in a different kind of magnet school and that sort of structure.So they start segregating the kids and so actually German manufacturing I think is exceptionalbecause those people who are you know running those manufacturing shops and managing thosestarted when they were 12 or 13 on the shop floor.And so the country is probably one of the best in the world at high-end, high-tech manufacturing,high-precision manufacturing, high-value manufacturing and all of that.And quite frankly they've been unaffected by low-cost competition from China and such.And so to the extent that we can learn, I think the one thing we can learn in termsof the hopefully in the US system is to maybe try to see if middle schools and high schoolscan be changed so that in those periods of time we start identifying kids who are clearlyshowing you know directions and where they are likely to be headed.Not everyone will show that, but I think the ones that show that I think the educationsystem needs to be set up to allow that.And so I actually got there by accident because of my dad.I think Gates and Buffett I think also got there by accident because they just had thisinterest and pursued it and I think that they probably had no understanding that their brainswere optimized to do what they were doing at that age.And so that's a huge advantage.I thought Arvind we decided we'd go all night, but you disappoint me so much.Maybe we can do that next year.Maybe people can bring their sleeping bags and such.No but no it's been a pleasure.I think like I said again I think you guys are very lucky to have a person like Arvindleading all of you.I think he's exceptional and loves what he's doing and you know I just think that thiswhole area of investing and value investing is so much fun, because it's one of thebroadest disciplines.You know, when you understand businesses and especially particular businesses and whatdrives them, you know you are pulling from multiple disciplines.You know, you are pulling from behavioral economics and you are pulling from human psychologyand finance and so many different areas, macro and so on, that's what makes it so muchfun.This was fun and a pleasure and I look forward to next year again.So thank you.