Mohnish Pabrai: How to Invest in an Overvalued Market (2021)

I never focus on what is happening in markets and, uh, you know, macro events and all of that. I think at the end of the day what matters is how does a particular business do over a long period of time. I think the important thing in investing is can I tell what a business looks like five years or ten years from now? What are their cash flow likely to be?

So, that right there is Monish Pabrai, the founder of Pabrai Investment Funds and, of course, the author of "The Dando Investor." Monish is a very, very knowledgeable investor, a very successful investor who predominantly models his investment strategy off of people like Warren Buffett and Charlie Munger. He recently sat down and did a Q&A with the students at Georgetown University, and my gosh, I am so glad that this Q&A session got put on YouTube because it is packed full of investing lessons that we can all take something out of.

So, in this video, I'm going to go through the best clips of that and kind of give my thoughts and opinions along the way. Make sure you do watch this one through to the end, not even for the algorithm's sake, simply because there are so many investing lessons that Monish gives in this talk. It is really fantastic. The full video is linked down in the description if you wanted to watch the full hour Q&A. But let's get stuck straight into it!

The first clip is Monish Pabrai talking about what he thinks of the market right now and what he's doing about it. I mean, I think one of the issues I was facing in the last few years is I was finding it difficult to find businesses to invest in in the United States. Things work, and we may now be entering a period of uneuphoria, which is fine, but things seem to be priced to perfection or even overpriced, etc., in the case of some good businesses and some not so good businesses.

I wanted to broaden out what I was looking at, and I could tell that there were some countries where just the entire market was cheap. These were places that people were not interested in investing in equities. Things like places like Japan, Korea, Turkey, and so on. Because these markets are so cheap, it becomes very tempting to just look at, you know, things that are trading at three times earnings and such and not really focus on the better businesses that may be at eight or nine times earnings.

So, these last few years I made several trips in, uh, to these countries and I met dozens of businesses, and we've got investments in Turkey and in Korea now, and we like those investments. I find this clip really interesting because he didn't let the pricey American market stop him in his tracks. Nope! He simply looked elsewhere.

That presents an added challenge of some of these businesses being, you know, geographically and culturally outside his circle of competence. He actually took the effort to go to those countries and actually have a look at those businesses in the flesh. I mean, he tells the story here of how he actually went to Korea with a friend of his and looked through like 20 different businesses while he was there. That is what that sort of stuff that sets you apart, right? Very, very impressive!

It shows you, you know, the lengths that some people go to to make sure they are 100% convinced about the business that they're going to make their investment in. Anyway, moving on, the next clip is Monish Pabrai talking about his own valuation strategy and how that has changed in recent times. So, let's have a listen.

Their model is really looking at these ownership stakes in businesses really as if you were the founder or the manager of the business and to think about it in the way the founding family would think about it. So, that basically stretches out time horizons. It also changes the type of businesses you invest in, and it's very tax efficient and actually, I think more satisfying.

Instead of buying a business that is undervalued, maybe, you know, 50% off or 60% off from what its intrinsic value is, you focus more on long-term compounders and businesses that can grow and scale over time. So, instead of just buying what I’ve done for a long time, which is discounted pies, the focus changes to growing pies.

Growing pies, you may have to sometimes pay a bit more for them because usually they're recognized as better businesses, but in many cases, the end result is a lot better. So, there you go! Think about your businesses as if you own the whole business. Think as if you are the founder and you are going to hold this business for like the rest of your life because then all of a sudden what's happening in the market currently really doesn't matter anymore.

You just stay laser-focused on the business; you stay focused on its ability to grow; you stay focused on its ability to compound your money, your investment over the next 10 to 20 years. This is really important. This is exactly how Warren Buffett looks at business as well. For example, one of his great examples is his investment in Coca-Cola. He bought Coca-Cola roughly in 1988, I think, and there've been, you know, periods of time where Coke has been really expensive and periods of time when Coke has been really cheap.

But at the end of the day, he goes back and looks at the business and says, "Does this have the ability to continually grow my money, compound my money out to the future? Is it a great business?" I think like I'm the founder. I think about it like I'm going to hold the business for the rest of my life, and that has led Warren Buffett to hold Coca-Cola in all market conditions since 1988. We've had the highest of highs and the lowest of lows.

So, I think that's really important. You know, when you go into an investment, think as though you are buying the whole business, even though you're not. Think about it like that. Think about it as though you are the founder of this business and you are in it for the long haul. Don't own a stock for 10 minutes unless you're willing to hold it for 10 years.

I find that clip really interesting. Anyway, the next clip I wanted to show is Monish Pabrai talking about how he's continually learning in the market and how he learns from his mistakes. Pay close attention to the end of this clip because he says something that's very relevant to today's market.

"What's your fund objective? The way that you're looking at stocks changed over the last five, ten years compared to those first ten years?"

Yeah, I mean, I think that in this business, you need to be a continuous learning machine. I think the one thing with investing is that all knowledge is cumulative. You know, as I get to more experience and I'm able to learn from especially the mistakes and also from other investors, the model changes periodically.

Well, I think the best lessons come from the losers. We don't really learn much from the winners. We do make some money and we pat ourselves on the back. So, I think when we lose money, those lessons get seared in. I had created a checklist maybe around 13 years ago, and it's a pre-investment checklist, and it goes through evolution over time. You keep adding more questions.

But what I found in that checklist is that, and it was created looking at all the mistakes great investors have made, where there was enough data before the investment was made that should have given the investor some pause, but they went ahead anyway. So, there was something that was visible as a, um, flaw in the armor, if you will.

What I found is I looked at these investments that these great investors made, and they didn't work out. They fell into about four or five categories. The largest category, the one with the biggest number of mistakes, was related to leverage. So, leverage was a big part of why investments didn't work out, and I've had multiple zeros, which is a 100% loss of the invested capital because of leverage.

So, I'm a lot more leery about going into situations where there's a great amount of debt. Another big part was misunderstanding of the moat and the competitive advantage—somehow not fully grasping the realities of the moat or the lack thereof. And then the third big piece was management and ownership—just kind of issues related to them.

Very interesting, leverage is the killer. And, of course, leverage is simply the idea of taking on money to fund some sort of growth investment opportunity in the hope to get a higher rate of return. So, you might own this, you know, small ice cream shop and it's quite popular, and you know that if you had double the space, then you could make three times the profit.

Now, in order to—so obviously that's a good deal; you should try and make that expansion happen. Now you could fund that expansion by yourself if you can, and that would be ideal because then you don't owe anything to anyone. But what if you don't have that money to go through with that expansion? Well, the expansion is still probably a good idea because it's going to lead you to that much more profitability.

But the idea of taking on debt to fund that expansion makes that business slightly higher-leveraged. Leverage is mainly measured through the debt-to-equity ratio. The debt-to-equity ratio just tells us how much of this business is funded actually by the owners of the business, how much is just funded through debt because, of course, it's debt over equity.

So, if you have a very high debt-to-equity ratio, then that means that the company is very highly leveraged because the debts far exceed the equity. Remember, the equity is just what the business owners—what part of the business that business owners actually own themselves. So, it's the total assets minus the total liability, so it's everything the business owns minus what they owe to others—that's the equity.

So, a very high debt-to-equity ratio means the business is very highly leveraged because the debt far exceeds the equity. A very low debt-to-equity ratio, say it's got a debt-to-equity ratio of 0.5, well, that means that the company has twice as much equity to what they have in debt. So, that business is much less leveraged.

It's interesting that Monish says that this is probably his number one mistake: going into companies that are too highly leveraged. I find that interesting because what has been the trend that we saw throughout 2020? It's companies really struggling and taking on truckloads of debt. So, it is very relevant to today's investing. So, you should really listen to Monish Pabrai's words here and maybe be very cautious about how much debt our companies are taking on.

Interestingly, he also brings up a past mistake of misjudging the moat. So, I thought I'd chuck in this clip here about how Monish Pabrai goes about checking whether a business has a strong competitive advantage.

"What are your thoughts on looking for that competitive advantage in businesses?"

Well, usually it will show up in the numbers. So, if the business has a strong moat and strong advantages, then you will see over a long period of time it's showing up in the revenue and the growth and the cash flows. You know, like if you look at a company like Mastercard, you can just look at numbers and see that it's a great business.

So, most generally will make themselves quite visible most of the time. And so, I think it's not that hard to sift through businesses and separate them into which ones are great and which ones are not so great. The issue that comes in is that usually the businesses that are great are usually well recognized as such and are usually trading at either full price or overpriced.

So, it's a combination of finding a great business and maybe either misunderstood or facing some temporary headwinds which has, um, decimated the price. In that circumstance, you could step in and do quite well. And this is exactly what we've been seeing. We've found these great companies with great moats, but they're usually priced as such.

So, I find it really interesting how Monish describes how we actually get to buy these great businesses. Quite simply, we have to wait for one of three things, essentially. We have to stay patient, wait for a short-term company-specific event, or a short-term industry-wide event, or a short-term market-wide event. That is when we get the opportunities, as Monish Pabrai says, when the price just takes an absolute beating.

That is when we are able to get into these high-quality businesses at a reasonable price if we can wait for those events to come along and smash the share price of good companies. That is when we jump in. But what about if we're sitting here right now, and we've already got a fairly well-established share portfolio? Probably in the current market conditions, we're looking at a lot of unrealized capital gains. What about us? You know, should we be worried?

Let's have a listen.

So, I think what really matters is the businesses that you own in the portfolio. What are their prospects in the next five or ten years, and what kind of revenues and cash flows generate over that period? And so, if they are growing at, you know, if you're paying 23 times forward earnings but if these businesses are growing at 20-30% a year and that growth would continue for, you know, five or ten years, those are not expensive businesses.

I would ignore whatever noise there is with temporary, you know, drawdowns and so on. And, uh, so, I think it's really a matter of—I never focus on what is happening in markets and, uh, you know, macro events and all of that. I think, at the end of the day, what matters is how does a particular business do over a long period of time.

I think the important thing in investing is can I tell what a business looks like five years or ten years from now? What are their cash flows likely to be? And I think the important thing that I learned from Nick Sleep is if you find yourself in the position of having ownership in a great business which has great growth prospects for a long time, the best thing to do is do nothing. Just—And we might have drawdowns and different things going on because, you know, when the index goes down, everything goes down.

But what we should focus on is the underlying business value. So, I totally agree here. You can't control the macro; markets will be cheap and markets will be expensive. So, just don’t worry about it. Stay laser-focused on each individual business in your portfolio.

Make sure the growth story is still intact. Make sure if you hold this stock, then you are still going to make money in the long run, and it's going to be able to compound both its business and your investment. Then just hold on to it. If it's still a great business and it's still going to compound your money in the next 10, 15, 20 years, then there's no need to sell it. Why would you want to sell one of those businesses?

So, I found that clip really interesting. Anyway, guys, they are the select few best clips, I suppose, or most relevant clips for investing in 2021 that we can learn from. However, there's still so, so many investing lessons. It really pained me. I wanted to keep this video's time kind of cut down so, you know, so that it works for, for YouTube, I guess.

Oh, and it pained me cutting out all of these fantastic clips. So, if you have an hour, I've left it linked down in the description. Go and watch the full interview because there are so, so many investing lessons from Monish Pabrai. It is insane! And maybe if you guys want, I can make a second video.

So, I'll see how this video does. Let me know if you'd like to see a part two with the other investing lessons. Leave a comment down below. Leave a like on the video, all that sort of stuff. I'll watch the analytics and see, but that will do me for today, guys. Thank you very much for watching. I hope you enjoyed it.

It's always good to learn from one of the best, and Monish is certainly up there. So, hope you enjoyed the video. Leave a like on it if you did. Subscribe to the channel if you'd like to see more videos like this.

And, of course, if you're interested in how I go about my investing, both my active investing and my passive investing, then check out Profitful. Links down in the description below in the active investing course, stock market investing for beginners. A lot of the stuff in there is modeled off of Monish Pabrai, Warren Buffett, and Charlie Munger.

So, if you'd like to learn more about this long-term value investing strategy in depth, then check out Introduction to Stock Analysis. But that'll do me today, guys. Thank you always for watching these videos. Without you guys, I don’t have this channel, and, you know, I'm back working as a physio, so I really do appreciate each and every one of you for showing up and watching my videos.

But now I'm rambling! Thank you very much, guys, and I'll see you all in the next video!