Mohnish Pabrai – one of the things that I learned from Warren Buffett is a team in an investment operation is an oxymoron

Mohnish Pabrai Lecture at Boston College (Carroll School of Mgmt)  Boston College – Nov 30, 2017
Distinguished Speaker Series Applied Fundamental Analysis & Worldly Value investing Professor Arvind Navaratnam Readers can find the video as well as a transcript of the talk below. Please note that although this is a full transcript it might contain errors and should not be relayed upon – furthermore this post is for information purposes only.

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Books mentioned in the talk

Arvind: Well, Mohnish, as always, thank you so much, we are incredibly grateful. I think this is your 7th time you've been speaking to my class and we are incredibly grateful, so thank you again.

Mohnish: Yeah, one thing, first of all, I am excited to be here. I think, is this the 7th year, is it, Arvind?

Arvind: Yes.

Mohnish: All right, that's great. First of all, it's a pleasure to be with everyone and thank you for taking the time. I hope this is worthwhile. I haven't exactly given this talk in this format before. So some of it, I am you know, I guess, you will be the first time recipients if you will, guinea pigs if you will, so please bear with me. But you know, there's a saying, I think it's an Einstein quote, I am not sure, where he says that take a simple idea and take it seriously. And I think that's a really important thing to keep in mind and I think even when you look at lots and lots of successful people or extremely successful people, right at the pinnacle of their careers, when you break it down, that quote is at the epicenter of how they got there. So usually, it's not something earth-shattering. Usually, it's something very simple, but they were intense about it, and they were just fanatical about it, and that's usually the fanaticism and intensity around a simple idea that gets you to the promised land if you will.

And so I want to just go through a couple of that kind of very simple ideas. So I know this is a high IQ group and I know that you guys can handle a lot more than I am going to give you today, but bear with me, it's not going to challenge your intellect, but I think what I am hoping for is that you will appreciate that these are not ideas that require high horsepower, but these are ideas that require intensity, extreme intensity of pursuit to get to the promised land. So during World War 2, 1941, there's an 11-year-old kid in Omaha, and he checks out a book from the Omaha Public Library – and Arvind, can you put up the cover of that book?

Arvind: What's the title of the book?

Speaker 3: One thousand ways to make $1000?

Mohnish: Exactly. What a beautiful corny title! So anyway, this kid in Omaha, also known as Warren, checked out this book from the Omaha Public Library and the good news for all of you is that you can go on Amazon after the class and order the book, it's still available. It was published in 1936, five years before Warren checked it out and Warren would tell you that this book is fundamental to his billions. In fact, the 11-year-old kid, after he read the book, made a statement that by the time he was 35 years old, he would be a millionaire. So one thing to understand is the book is not talking about how to become a millionaire. It's just talking about how to make a thousand dollars, and it's a thousand dollars in 1936 dollars which my estimate in 2017 is no more than $15,000. I don't think the inflation from then to now is more than 15x.

[00:05:00]

So it's not teaching you – the book is not teaching you how to become a millionaire, but the 11-year-old kid reads the book, is super excited about it, still remembers the title, and basically makes that statement. And actually, when he was 35 years old, which is 1965, he was well beyond a million. I think in 1965, my guess is, Warren might have been maybe 5 or 7 million by then, which would have been about 40 or 45 million in today's dollars.

And so, even before he was 11 years old, and I am gleaning some of this data from some of what Warren has said and I am inferring from what he's saying in the book is that even before he was 11 years old, he had figured out that compounding is the eighth wonder of the world, which is another quote attributed to Einstein. So the 10 or 11-year-old Warren had figured out that compounding was the eighth wonder of the world and then after he had figured it out, he needed – which I am going to demonstrate soon to you, but he needed seed capital. So compounding is magical, and it's magical from extremely small sums, but you need a seed to start growing and growing over a long period of time. And so, just hold that thought for a second and we will come back to it and I want to kind of digress and go back about four centuries or actually more like three centuries and I think 91 years or so or 89 years or so.

So in 1626, which is almost 400 years ago, it's widely rumored that the Dutch bought the Island of Manhattan from the Native Indians and at the time that deal was done, without any bankers I might add, when that deal was done, it was done for $24. And so for $24, the undeveloped land, which makes up the Island of Manhattan now, passed in ownership from the Indians to the Dutch and Peter Minuit was the guy representing the Dutch. And the reason I bring up this story is that this was actually mentioned and I became aware of this story in one of the letters, Buffett wrote to his Buffett Partnership investors in the late 50s. So this story was relayed by Warren to his investors maybe in the early 60s but north of 50 years ago, long time back. And the reason Warren brought it up at the time, is that it appears when you look at that $24 transaction price, and you look at what is the value of even undeveloped land in Manhattan today, one would think that the Indians got taken.

But let's just say that the $24 was given by the Indians to their Chief Investment Officer and the Chief Investment Officer was told to invest this amount for the benefit of the tribe for several centuries or several generations, and let's say for argument's sake that our investment officer wasn't too bright and he could just manage something like a 7% annual rate of return. And so if you had $24 in 1626, and it was growing at the rate of 7% a year – one of the things I want to do in this class and I think most of you may be familiar with is you may be familiar with the Rule of 72 – and so one of the important things about compounding is to be able to do the math in your head.

[00:10:00]

The whiz kid in Omaha in 1941, then and now, does all his compounding math in his head. I've been to his office, there is no laptop or computer or anything. He's just doing math in his head even now. And doing math in your head is a very big advantage.

So if you are compounding at 7% a year, Rule of 72, in 10 years, your money is going to double. So, in 1626, they have $24, and in 1636 they are going to have $48, and 1646, they are going to have $96, and so on. And then we know that a double comes in 10 years, if you take a 100-year period, that's 2 to the power of 10, one of my most favorite numbers, 2 to the power of 10 is 1024, so let's throw away the 24, because it makes the math harder, we don't want any hard math, we want easy math. Arvind makes all his assignments hard, and I just want to make life as easy as possible for you guys. So if you go through 10 periods of doubles, that's 1000 times what you start with. So if you had $24 in 1626, it was $24,000 in 1726, and then it was $24 million in 1826, and it's $24 billion in 1926, and it's $24 trillion in 2026. But, Arvind will quickly remind me that we are not in 2026 right now, we are in 2017, so I am going to take that $26 trillion just to make him happy and cut it in half by making it $13 trillion which would be what it would be in 2016.

And so, basically, if the Indians had gotten the 7% return, they'd be at 13 trillion. And then the other question in front of us is what would be the cost today of undeveloped land which is let's say in a place like Manhattan at that size. And I don't know the answer to that question, these are difficult questions that Arvind likes to ask, but I do know this that the total wealth of the United States, every man, woman and child, everything that we have in the US is about 100 trillion. And if the entire country, everything is a 100 trillion, the Island of Manhattan, even with all its buildings and everything else is way under 13 trillion, because we've got a lot of assets in this country.

And so the Indians actually negotiated quite a good deal. The problem ic they had an incompetent investment officer, who couldn’t bring the bacon home. And of course, we are going to make sure that such incompetence is permanently banished from places like Arvind's class. So the thing is that, let's come back to the kid in Omaha, we will come back to the Indians in a few minutes, but let's go back to 1941 and the kid in Omaha. So, the kid checks out the book, he's looking very, very intensely in the book to figure out how do I get a $1000, and the reason why the $1000 is important is because once he has the $1000, he already knows the math and compounding, he's very smart, probably at 9 or 10 years old he'd figured out what I just told you about the eighth wonder of the world, and he just wants to get the $1000 as quickly as possible, so then he can put it on his compounding engine.

[00:15:00]

And he was lucky, in the sense that his dad was a stockbroker, and he used to hang out at his dad's offices, the brokerage firm with all these kind of handwritten quotes and all that in Omaha and kind of was all around kind of stocks and quotes that were wiggling around and all that, when he was 11 years old. And in fact, he bought his first stock when he was 11 years old, and Warren likes to say that he was wasting his time until then. He says, he had a slow start because he bought his first stock at 11 and was kind of an underachiever till then if you will.

And what he did is that he knew – he didn't have the framework completely, but he knew that within these wiggling prices and these kinds of gyrating quotes and all that, there was a fortune to be made. And he knew that if he had a little bit of capital, like his $1000, and he could make investments in stocks, and if those investments – so here's what Warren is saying, he's 11 years old, he's saying, in 24 years, I am going to take 1000 after tax, to a million. Now, I haven't done the exact number on what the annualized, rate is on that, let me just put it this way, it's much higher than the mandate given to the CIO of the Indians. It's probably north of 30% a year is my guess. It might even be, maybe low 30s, I would say probably a year. But it's a significant rate of compounding. So the 11-year-old kid is confident that he's going to compound at some astronomical rate if he can just get 1000. And so he goes very intensely, reads the book, really excited about it, and then he sets up a whole series of businesses. You can read about it in the Snowball, and you can read about it in Roger Lowenstein's biography. But my couple of favorite businesses he set up, one was the Wilson Coin Operated Company. Just to make sure I am not repeating myself, raise your hand if you've heard of the Wilson Coin Operated Company.

I see Arvind frantically raising his hand, but I also see that he's done you a big disservice. He gives you all these difficult assignments, and he doesn't talk about the Wilson Coin Operated Company. The Wilson Coin Operated Company is one of the most important business lessons to learn. Let's go into the Wilson Coin Operated Company since it's such a great business. So, first of all, I will take a step back. Warren was in Washington DC, his father was a Congressman, he was a teenager, he was in high school, and of course, he was very smart. But he'd already read this book at 11. He knew the name of the game was not to be the best student, the name of the game was to build capital, and to build capital by having different businesses. And since about six or seven years old, he'd done one business after another, but he became friends with a guy named Don Danley, and Don Danley eventually was a valedictorian of that high school. And I met Don Danley several times in Omaha, and he, unfortunately, passed away a few years back, but a wonderful guy and I had so much fun talking to Don about the teenage Warren, it was just a blast to talk to Don about that. Those were a lot of fun times. And Don went on to work on the space program, and he was part of the group that put the man on the moon, and so there was a lot of horsepower deployed to put a man on the moon and Don was one of them.

And so anyway, Warren becomes friends with Don and one day he goes to Don's house, and Don was a tinkerer, I mean, you could take to him some beat-up car that doesn't run, and he'd figure out what was wrong with it and make it run. And one day Warren went to his house, and he saw that Don was working on this old dilapidated pinball machine which didn't work.

[00:20:00]

So Warren asked him what he was doing, he said, "Oh I bought this pinball machine for like $15 or something, and I think I can fix it." And so Warren was just watching Don Danley at work fixing this pinball machine, and in a few hours, Don Danley had that pinball machine working.

So then Warren tells him, "Hey Don, do you think you can fix up more machines? Can we buy more machines and fix them up?" He said, "Yeah, most of these machines, there's nothing major wrong with them, it's pretty easy to fix, and basically they don't work, people just want to – they want to get rid of them, they take up space and stuff." So he says, 15-20 bucks, 30 bucks you can buy a machine that doesn't work. And so Warren sets up a company, and of course, there's no incorporation or anything done but it's called the Wilson Coin Operated Company, and they invented a character a fictional character named Mr. Wilson. And what they did, the two of them, the two boys, these 15-year-olds, they would go to barber shops in DC, and they would go tell the barber, "Listen, we represent Mr. Wilson, our boss is Mr. Wilson," because they knew if they said, we are our own bosses, they'd be laughed out of the shop, they said, "Look, Mr. Wilson sent us and we work for Mr. Wilson, and Mr. Wilson has a proposition for you. He wants us to tell you that we are going to give you this pinball machine for free to put into the corner of your barbershop. And we are going to come by once a week, and whatever money is in there, we are going to split it 50-50 with you. And Mr. Wilson told us to tell you that it's a great deal for you and it's a great deal for Mr. Wilson. So do we have a deal?"

And so this barber said, yeah, sure, put it in the corner. They said, there's no downside, I got the space, I'd put the machine. So they went to barbershop after barbershop, and once they'd get the deal done, then they would buy a pinball machine, Warren would put Don Danley to work to fix the machine, and then they'd put it in these barbershops, and they had 30 of these machines in different barbershops, and then Warren said, we'd go once a week and open up the machine and pull out the quarters, and then all the money people had been putting to play pinball while waiting for the haircuts. And he said that the first time he went, the first machine had $5 in it. So they gave $2.5 to the barber, and they kept $2.5. And Warren at that point thought, he died and went to heaven, because he – I don't know what Arvind's been teaching you about return on capital but if you invest $25 and every week you are getting back $2.5, the return on capital, let me just put it to you this way, it is higher than almost any American business, One of the highest return businesses you could ever be in. And of course, the kid from Omaha, who's a whiz at math, loved this.

And then, he's thinking, okay, $2.5 from this machine is $10 a month from this machine, it's a $120 a year, and I got 25 of these. I got like $3000 coming to me, and yeah, my buddy Don Danley is getting half, that's okay, I like him, but I am still kind of cleaning up because I didn't have anything to do with it, I just went and did my deals. And then, Warren also noticed that Don Danley was really good at fixing cars. So he found this ad for this Rolls Royce which didn't work, didn't move available for sale for $200, and he asked Don, "Hey Don, do you think you can fix this car?" Of course, this is a guy who put people on the moon in the future. Of course, he can fix the Rolls Royce. And Don said, "Oh yeah, sure, I can fix it, no problem."

So they bought the Rolls Royce for 200 bucks, I think they put another 200 bucks of parts into it to get it [inaudible 00:24:47] up and working, and then they started renting it on the weekends for weddings at 100 bucks a weekend. And of course, again, return on capital, through the roof.

[00:25:00]

But that wasn't it. Monday through Friday, they drove to school in the Rolls. So these two kids would roll into Washington High, whatever the name of that school was in the Rolls Royce, Warren had a fur coat at the time, so he'd come out with his fur coat in his Rolls with Danley next to him.

Anyway, so, you can see that the kid from Omaha at 11 years, figured out that he needed a $1000 and then by 16 or 17, he's pulling down a few thousand a year, and I think when he was 17 or something, he graduated high school really early, 16 or 17, he had about 9000 saved up. And then of course he insists with his dad that he was going to pay his own way through college, the tuition then was slightly less than BC charges now, and basically he went to college and he told his dad, give your money to my sisters, I don't need it, I am on my compounding engine, I got my base capital. And so the reason why Warren is a billionaire today, many times over, is not because he came up with something innovative or anything esoteric. I mean, the Google guys came up with something innovative, the iPhone is amazing, there are lots of businesses which are around some whiz-bang technology and some very smart people doing some very smart things. But that is not how Warren made it. Warren made it on very commonly known facts, and very commonly known mathematics. The difference was from the age of 11 till now at 87, he's intensely obsessive about it, and he's been obsessive about compounding for his whole life.

And of course what he was missing at 11, he said, he screwed around with technical analysis, whole bunch of different ways of trying to figure out how to predict what stocks would do well in the future because he knew that he had to get kind of high rates of return, but he was basically in the wilderness until he came across Ben Graham and went to Columbia and then he got the framework and then of course he was – once he had the framework of value investing, then he was off to the races, because he had his base capital and he'd figured out how to compound at high rates, and he went off and did his thing.

And so, the important thing was that there are two ways you can kind of, I would say, ingest our interaction today. You might go back home or think about tomorrow, and you might say, oh yeah, Rule of 72 yeah, compounding yeah, the eighth wonder yeah, it was a good talk. That's one way to ingest the data. The second way to ingest the data is to do a 180 which is to become like the 11-year-old kid in Omaha and become fanatical about it, where you say, listen, compounding is very critical. And now, let me go about, for the people in the second camp, back to the Indians. So the Indians did their deal, the 1626 and all that, so let's unpack that.

So, why does Einstein say that compounding is the eighth wonder? Well, the reason it's the eighth wonder is, I gave you some assumptions, I told you 7%, I gave you this 400-year period, and I gave you the $24. But you can also if you are fluent in this, you can go kind of massage this a little bit. For example, if you go backward in time, so let's say, the deal was done in 1616 instead of 1626, you could have done the deal in 1616 at $12, the outcome would be the same.

[00:30:00]

Or you could do it in 1606 – I am sorry at $6, and again the same outcome; 1596, $3; 1586, $1.50; 1576, 75 cents, and you can keep going back, you will get to 1 cent.

So, you can make 1 cent become 13 trillion or 12 trillion, sorry we were at – yeah, $24 so 12 trillion. Or what you can do is – so the way the compounding and Rule of 72 works are there are three variables. So one variable is the amount of capital you start with. The second variable is your rate of compounding. And your third variable is the length of the runway. So if you do 7% a year, it takes 10 years. If you do 10% a year, it takes 7 years. So one of the beautiful things about Rule of 72 is the rate of return and the number of years is interchangeable. It still works, the math works the same way. You can do 7%, it takes 10 years, it doubles, or you can do 10%, it takes 7 years to double. So the thing is, this is very elastic and beautiful math.

So, now you know the problem we have as humans, and this is one of the problems Warren realized, if you asked Warren, "Hey, Warren if you could have any gift that anyone could give you, what would you like?" And he doesn't even hesitate for a second when he says this, he says, "Look, when they look at my corpse, they should say man he was old." And the reason he says that the only thing he desires is a massive runway. He wants a huge runway. And why does he want a huge runway? He wants a huge runway because he's obsessive, fanatical about this. So he knows those three variables, and he knows the runway is a very important part of that. So, if you look at the 40-year-old Warren Buffett, the 40-year-old Warren Buffett, 1970, net worth less than 30 million. His net worth when he was 40 was less than I think 1-3000th of his net worth today if he hadn't started giving the money away. So, when he was 50, his net worth was around 300 million, maybe 3 or 400 million approximately. It was less than a third or 1% of what it is today. So 99.75% his net worth has come after the age of 50.

So this is the thing. One of the things what compounding is that because there's geometric, humans aren't used to thinking geometrically. You have to become fluent in thinking geometrically in your head. And so, again, let's go back and massage those three variables. So you have a length of the runway, starting capital and compounding rate. And this kid with the Wilson Coin Operated Company, when he's 16 years old, he was looking at the life expectancy tables, at the age of 16 to know what the runway was. I guarantee you, every year of his life, he looks at the life expectancy numbers. And he's now I think, when he looks at it, he gets sad, because it's not that long, but I think he'll blow past his expectancy levels because one of the things, if you are in alignment, you tend to do better, health-wise and runway wise. So that's good.

But the thing is that – the important thing is that – Arvind, what is the average age of the class ballpark?

[00:35:00]

Arvind: I would say, it's about 26 on average.

Mohnish: Yeah, so you know one of the unfortunate things is we didn't have this talk 15 years ago. That's very sad because we have lost huge amounts of the runway, unfortunately. But the good news is that I think for most of you, you are probably going to live past 90, you might even live past beyond that, I mean, we have to see what happens with medicine in the next half-century or so. You might – certainly, a good portion of the class might blow past a 100, but I think 90 is a pretty safe bet. So, if you look at 90 and you look at let's say 26, so we got 64 years. It's not the best, but it's workable. We can work with 64 years. And so, here's the thing you got to figure out. We know the length of the runway. Unfortunately, unlike the Indians, you don't have 400 years. You got 64 years.

And the second variable is starting capital. Now, the second problem you guys have is you didn't start the Wilson Coin Operated Company when you were 15, and that's very unfortunate. But the thing is that you need to quickly, after this class, do an analysis of net worth, very important to do an analysis of net worth. You might be disappointed when you do that analysis because of all these high tuition bills and everything else. But the thing is that you want to as quickly as possible get away from the crutches of Arvind, and start earning some real money. You need to figure out a way like that book said, how to get to 1000. 1000 is not going to cut it for you because your runway length has already been cut short. We need more than 1000. We need maybe like 100,000 or maybe a quarter million, and then we can get going.

But the thing is that – so we have control, effectively we have control over the length of the runway because statistically, that's going to probably work in your favor. The second thing we have control over is our savings rate. And so the other thing that's important is you've got to make sure that you are stocking it away. And if you have any difficulties stocking it away, how many of you have heard of Mr. Money Mustache? Raise your hand if you've heard of... All right, a couple of humans have heard of Mr. Money Mustache, all right. They are not very happy to acknowledge that they've heard of him, but they are just kind of tentatively acknowledging. Anyway, I have a blog, it's called Chai with Pabrai. Sometimes if you get bored, you can go to that blog, and I've got – some of the earliest blogs I did which was about a year ago, are on Mr. Money Mustache, and so Mr. Money Mustache, he's a software guy, he graduated at 22, he didn't have any money, and he made up his mind that by 30 he was going to be retired and he was never going to work again. And I think he accomplished that goal well before 30, I think at 28 or 29 he was retired.

, If you ever want lessons on – actually, it's worth going through and seeing how he did it, it might blow your mind a bit, kind of how he lives his life, but it's kind of fun to look at it, and I see what looks like a few Starbucks lattes in front of humans, let me just assure you, Mr. Money Mustache would not be caught dead in a Starbucks. He ain't spending 4 bucks or 5 bucks or whatever on coffee, not happening.

[00:40:00]

But anyway, it's worth looking at Mr. Money Mustache. You might find his ways a bit extreme, but you might still be able to you know get a few things out of it. I mean, I think his gas usage in a year might be 2 gallons. He's biking everywhere. It's a fun lifestyle to look at how he goes about living his life. And the fun part is, he's got a wife who's amazingly not left him yet and actually she's wholehearted with him on much of this journey. So it's kind of a fun couple. But anyway, the thing is that the savings rate is important since you didn't do the Wilson Coin Operated Company.

And then the third piece which we don't have as much control over is the rate of compounding. And of course, the reason you are in Arvind's class, I would hope, is to increase your rate of compounding, and hopefully he's been he's been imparting some good lessons to you on that front. So, the thing is that a few years back, my daughter had just finished high school, and she had spent her summer working before she started college and she made $5000 that summer, and I talked to her about opening an IRA and putting the 5000 in the IRA and I asked her a question. I said, look, you are 18 years old, at the age of 68, if this 5000 grew at 15% a year, what would it be. Now, you will notice, I pick all these years to make the math easy for me, the percentages I pick to make the math easy for you because I am not the sharpest tool in the toolbox, you will soon realize that. And so 15% a year doubles in five years. 50 years, 2 to the power of 10, I already told you that's my favorite number. So that becomes 1024. We throw away the 24, it's 1000. So the 5000 becomes 5 million.

Now, when I was talking about this to my daughter, I had just picked her up from the airport. She goes to school at NYU and the flight came in at 2 in the morning, and I picked her up, I said, this is a great time to impart lessons on compounding. And so, as she's dozing off, in the car, we have like a 50-mile ride, I said, this is just perfect. And so I started talking to her about the 5000 and the IRA and the 15%, and I am getting no reactions and then I mentioned the 5 million and suddenly she's wide awake, "Wait, wait, how did that happen? What happened? How did you get the 5 million?" And then I went through the math again with her, and of course, the good news was it got seared in. So, the following year, she did an internship and this cheapskate company in New York which is unnamed, basically likes to use slave labor for interns and it was a very low amount she got paid. And I think over the summer when she worked for them, she made like 3000 or something. And she already knew that she should have made like 6 or 7000, and it wasn't the 3 or 4000, it was 3 or 4 million that had been taken away from her. And without my prompting her, during her exit interview at this place, she said, look, I had a great time working here, but you guys really need to change your policies, it is really terrible to take advantage of students like this, not pay proper wages, and it was very important for me to make the 7000, I didn't make it, it's terrible shame on you. And I was so happy that she did that. But the good news is that lesson of compounding was seared in, and so now, even when she has a two-week break or something she's trying to find work to keep pounding that money in the IRA and so on.

So, the thing is that at 18, with 5000, it becomes 5 million. 19, again, whatever she saves, you multiply 1000 by 69, it becomes that number. At some point, she's going to graduate, get off my payroll.

[00:45:00]

I think that date is about a year and a half away, and then she might have real income, and again, I made her listen to Mr. Money Mustache, I don't think she's going to adopt his lifestyle but a few things might have rubbed off on her about Mr. Money Mustache, and so the important thing is that I think she realizes that the savings rate is important. And of course, the 15%, many of you might say, well, that maybe too high. Yeah, it maybe, but what I told her is that, basically, go extremely concentrated and I told her, if she wants, I can manage it for her. So she said, that's fine. So I put the first 5000 in one stock, just, we are not going to screw around with this. And we are going for a much higher rate than 15, and so far I have not blown up her capital, so we haven't had any difficult conversations yet. So that's going pretty well so far. But, Arvind, can you put up the second picture? I prepared so well for this talk, I had to come up with two pictures. People come up with all these PowerPoints.

Arvind: Can you guys see the image? Okay, great. They can see it Mohnish.

Mohnish: Okay. So, maybe one of you can raise your hand and just read off the letters and numbers.

Arvind: Brian, yeah, why don't you do that.

Mohnish: Go ahead.

Brian: COMLB26.

Mohnish: Yeah, so this is the license plate on my car which my daughter took away, it was a BMW 6 Series, nice car, top down and all. But anyway, what does the license plate mean?

Arvind: Mohnish, one student said, compounding my life. They are moving in the right direction.

Audience Member: I think about 26%.

Arvind: Yeah, repeat that again.

Audience Member: Compounding my life by 26%.

Arvind: Compounding my life by 26%, one student said.

Mohnish: You know, the thing is, when I drive this car in Southern California, in Irvine, I am trying to impart lessons on compounding to my fellow drivers who I share the road with as community service. So, I didn't want to make it really complicated for them, I wanted to make it simple. So you are on the right track, but we are not quite there yet.

Arvind: Yeah, go for it.

Audience Member: [inaudible 00:48:17]

Arvind: Yeah, compound...

Audience Member: 26%.

Arvind: Compound 26% one student said.

Mohnish: That's perfect, yeah, the LB is pound, isn't that great. [inaudible 00:48:30] California is they only gave me seven letters or numbers. So I had to kind of convert pound into LB. But the reason I did that Compound 26 plate was so that I am reminded of it as an important mantra. So, when I first heard about Buffett in '94, it was very exciting. I was an engineer. I really hadn't spent – I mean, I don't think I'd ever really – I might have bought a stock or two but never done anything well in the market or anything. And so, what I realized when I – and I was lucky, in '94, the first couple of biographies on Buffett had come out and then I read those and then I was able to look at the Berkshire Hathaway annual letters which opened up a whole big world for me, and that was great. But what became very apparent, very quickly, in reading through the biographies was that Warren was all about compounding, and he had had from 1950 till '94 when I first heard of him, he was compounding at north of 30% a year.

[00:50:00]

In 1950, he had about 10,000, so that 30% was on the 10,000 which is very significant, but then, he got OPM, other people's money, and he got a cut out of the other people's money, and of course that put a turbo path on his compounding engine and such, and he ended up with, even at that time, in '94, a very significant net worth.

And so, I was very intrigued by both his approach to investing and his intensity on compounding, and I said, you know, this compounding game looks like a very fun game, and it can be a very profitable game. And what had happened at that time in '94 is I'd sold, I had an IT company, I'd sold some assets and after taxes and everything I was left with about a million dollars, which I really didn't have any need for or use for. And the first time I had money ever because until that time I had borrowed on credit cards and was always in debt trying to grow the business and such. And so this was the first time actually that my personal balance sheet was in the black if you will, and there was no debt and such outside of kind of financing receivables and so on. And so I had this million and I said, what if we put it on the Buffett compounding engine and what if we go for 30 years at 26%. And 26% doubles every three years and we again get to my favorite number, 2 to the power of 10, and the million becomes a billion. And I said a billion is a lot better number than a million. And the best part of the billion is, I can do this while keeping my day job, keep running my company, but I can try to see if I can figure out investing and figure out how to get – and of course I was being modest with the 26%, I mean, Warren, when he was 11, was looking at kind of like low 30s in compounding.

And for the most part that 26%, I mean, I think from '95 to '99 was – 2000 was north of 70% a year. I mean, I'd done really well. That money had gone more than 10x in five years. And it continued at a very, very high rate even after I started Pabrai Funds till 2007. I think from '99 to 2007, Pabrai Funds before my outrageous fees was about 36% a year, and after my outrageous fees were kind of the high 20s. And then, of course, we had the financial crisis, we went down a lot. We went down, two-thirds and so that crimped the compounding rate. But then from 2009 onwards again it took off and it's done well since. So, the bottom line is I don't know this game I started playing in '94, is supposed to end in 2024, but the thing is 2024 which is about seven years away, one of the things this is kind of interesting to me was in '94, I was exactly 30 years old and in 2024, I was going to be 60. So I said, okay, we will kind of compound from 30 to 60. But now that I am a little bit older and wiser, I said, why don't we compound till one day before dying, why stop at 60, because we are going to keep maximizing the runway. And so I am also hoping that I get super old before I lose my marbles and don't know what I am doing.

So, I think the important thing is that just keep these things in mind, starting capital, savings rate, length of the runway, and then the fourth variable which is your rate of compounding. I think there you just have to, if you are – Warren was able to do it at high rates because he was very focused on that. For him, the high rates were very important, and so he sought out places and kind of crevices in the markets, which gave him high returns. And he still does the hunt that he used to be when he was in his 20s if you will, still interested in similar things if you will. And so I think with that Arvind maybe we will open it up and go on to questions.

[00:55:00]

Arvind: That sounds great Mohnish. Thank you so much. Maybe we can start as the students kind of assemble their questions, I've been asking every speaker this to start this year, which is how do you think about your firm's competitive advantage. What are its components and how do you see that competitive advantage growing or decreasing over time?

Mohnish: Yeah, well, I think that's a really good question. So, when I started Pabrai Funds, I had never worked in the investment business, I really quite frankly didn't even know exactly what a hedge fund is and such, and I took some pages from Lowenstein's book and took it to this lawyer. I said, listen, I want to set up an investment partnership like the Buffett partnerships, here are the rules on these pages, please convert this into a document that – or a few documents that create a legal structure that we can put – at that time my friends were interested in investing. It was not even supposed to be a business. So they were eight of us, they were going to put a total of million dollars into this, and I was going to manage it, and I wanted to manage it using Warren Buffett's rules with zero management fees, 6% hurdles, one-fourth over 6% coming to me and so on and so forth. And similar rules, redemption once a year and not talking about the holdings.

So whatever rules I could see that he had used during his investment partnership years, I cloned those, and it took me a few years to realize that the mindless cloning that I had done in '99, actually gave Pabrai Funds huge advantages, and it created a moat that is impossible for my competitors to cross. So for example you know – and what I did from '99 till now is I have tried hard to educate my current investors and potential investors about the importance of these attributes whenever they are giving a manager money to invest. And of course, some of these attributes, it'd be very hard for them to find managers who will give them that type of deal or rules. So, let's talk about one of the rules which I copied from the Buffett partnership which is no management fees and the 6% hurdle and taking one-fourth over 6%.

So the thing is no management fees is an impossible fee structure for almost any investment operation that has a team. How are you going to pay the team? And of course, one of the things that I learned from Warren Buffett is a team in an investment operation is an oxymoron. You cannot delegate any part of the investment process. You can't kind of look at cliff notes versions of businesses before you invest in them. You should know the businesses, and you can't know the businesses if your analyst is doing all the work. So at Pabrai Funds in '99, when we started with 1 million, and now with about 840 million, there's no analyst, there's no associates, there's no team. I have a few part time admin assistants. I used to have one part time admin assistant but now we've got our family foundation, few other things, so there's a little bit more admin backend needed if you will. But there's no full-time employees and I think the total payroll of even all my admins and everything is probably under 150,000-200,000 a year. So we don't have really much in terms of fixed cost.

[01:00:00]

And most investment operations at my size, they will charge 1 and 20 or 2 and 20; and so at 1 and 20, you would pick up 8.4 million in fees according to what Buffett calls just for breathing. And it's stupid to pay a manager 8.4 million just for breathing, I can breathe without the 8.4 million. And so one of the things I've made sure in every letter I sent to my investors, I make sure that I reinforce for them the importance and the good deal that they are getting when they don't pay management fees. And so what happened is many of my investors, when they came and invested in me, it may or may not have been important to them that this was the fee structure. For many of them that came to me, this was very important. But, after a few years with me, for almost all of them, it becomes very important, because I am really good at brainwashing. I brainwashed them into understanding not to accept 1 or 2% management fees because they've been taken to the cleaners, because if an investment manager earns you 10% a year and is charging 2 and 20, well, you are down to 8% after paying the 2%, then you pay 20% on the 8%, another 1.6%, you pay 3.6%, 36% of the returns have been swallowed up in fictional cost. And when you compare that to the S&P, it's really hard to beat the S&P if you've got 3.6% in fictional cost being taken off the top. So, that's the reason why most active managers underperform.

So I never realized when I cloned the zero fee structure, I cloned the zero fee structure because I was starting Pabrai Funds with a bunch of very close friends. I thought it was a very fair structure and I thought that if I don't make them at least 6% a year, I don't deserve to get anything. And so it just made kind of sense to me from an ethical perspective. But what has happened since then is not only is it ethical, it's actually created a moat and it becomes a competitive moat. So, even a much larger shop cannot cross the moat. And so I think that the zero fee structure gave me a huge moat. I think that copying the second part of the Buffett partnership which was not having analysts has also given me a huge moat. Basically, I love figuring businesses out, I love hunting for bargains and I love the fact that I have no payroll. And why give all the great exciting work to someone else and then pay them a huge amount of money to do that when it's so much fun to do it yourself?

So I think these are some of the things that have been a huge competitive advantages, and I would say I am grateful to Warren that I stumbled into it, just by trying to clone. In fact, today, someone sent me a recommendation of a book and this guy said that the title of the book was called Copy, Copy, Copy. As soon as I read that title, I ordered the book because I am Mr. Copycat, I have no original ideas. I just want to copy, copy, copy, and so hopefully in a few days that book is going to show up and I am looking forward to reading it. Other questions Arvind?

Arvind: That's great Mohnish. We are going to jump into more, but just on the investment side, how do you think about your investment, your competitive advantage? So the capital base you talked about in your structure that's really profound. Regarding your investment process do you think about competitive advantage there?

Mohnish: Well, actually one thing that has developed recently, I think, one of the things is that the key to doing well I think in investing is to be inactive.

[01:05:00]

Spend time talking to BC and HBS students and talk to them about Peter Minuit and the Indians and the Wilson Coin Operated Company instead of fiddling with the portfolio. The less activity you have in your portfolio, in general, the better you are. The single biggest mistakes I've made historically is being too active. So, smaller team sizes will in general lead to less activity because you are going to have limited time to come up with ideas and things. I mean, if I had 10 analysts at Pabrai Funds, high IQ guys cranking all the time, I mean, I'd be presented with three ideas a week, and they'd all look great. And it would – I am almost sure, the result wouldn’t be so good.

On the investment side, one advantage is smaller team size means that you are going to have – in general, it's just going to take you longer to get through stuff, which is good, it's an advantage. And the second thing that's been a more recent advantage, and I didn't realize it until just last few weeks, is that I've made a major pivot and I made some changes in the last year, where more like, last I would say 18 months or so, where I've very aggressively started moving into investing in India. And I picked India, for two reasons. One is, I would say, it's been almost nearly two years that I haven't found much to buy in the US. And I am a bargain hunter. I like to buy things at half off or less – is the US has been very slim picking from my vantage point, been very slim picking for a very long time. And the things I've been able to find have been kind of these I would say anomalies. I found for example, the airlines were misunderstood and mispriced about 14-15 months ago, and so we were able to put some money in the airlines. And then I was actually a quarter ahead of Warren and then the following quarter Berkshire is into airlines as well. So that made me feel good that I wasn’t completely losing my mind if you will.

But the thing is, we had to go into an area and a very ugly industry like airlines, where pricing is set by your dumbest competitor, high capex, unions and consumer taste and just every possible thing that is horrible about – the opposite of the Wilson Coin Operated Company is the airline industry. And that's where we were finding stuff. Whereas what I found is when I went and looked in India, Indian markets have moved up, but I think there are still plenty of pockets in India, which have been a lot like shooting fish in a barrel. Warren's partner Charlie Munger says that he wants to shoot fish in the barrel but only after all the water has been let out. So in India, I don't think the water has been let out of the barrel, but the fish is still in the barrel, they are still swimming around, there's still some water in there. I haven't found a way to get the water out. But that's still way better than fishing in the ocean.

And so another competitive advantage which has developed I would say in the last year or two has been India, and then just to give you some statistics is that this I myself found it stunning is that the amount Pabrai Funds has invested in US domicile companies now is under 13% of the portfolio. Out of the 840 million, it's the lowest number I ever had. I mean, historically, we've had almost everything in the US, and India is like 45% of the portfolio. So, there's been a huge change going from nothing in India to 45% over the last three years, and at the same time not finding much in India.

So, this particular advantage with India, as I was thinking about it, I realized that I had some natural advantages, I happen to be Indian, which was a good thing, I am familiar with the language and been running a foundation there and obviously been going back and forth and such.

[01:10:00]

So for me to figure out these businesses – I am in India every six or eight weeks now, which is a lot of fun – a lot of – when I look at the people that I would normally think of as very good investors, basically those folks are really good investors but they aren't fishing where the fish are. And it doesn't matter how good a fisherman you are if you are not fishing where the fish are.

So, I think the US market has a problem in the sense that the number of listed public companies of US is now down to less than 3700 whereas 20 or 30 years ago it was close to 8000. So, the number of publicly traded companies in the US continues to go down, which is a problem, and the number of brain cells employed picking through those 3600 odd companies continues to go up. And when you combine the two, and then you get these huge runs in the market as we've had, you get what I would say pricing to perfection. I am sure there are opportunities even in US markets. There are always opportunities in all markets, but I think those opportunities are at a whole different kind of layer of or magnitude of the difference between the US and a place like India.

So, that's a more recent competitive advantage. Again, I am too dumb to figure these things out in advance. I just stumble upon them. My full name is Mohnish Forrest Gump Pabrai, and I am very happy with my middle name.

Arvind: That's wonderful Mohnish. Thank you. Other questions.

Audience Member: I have a question regarding running – one of your holdings is doing quite well, it's like an [inaudible 01:12:14]. You think that we should lower down as a percentage in the [inaudible 01:12:19]?

Arvind: Mohnish do you want me to repeat the question?

Mohnish: That would be great actually Arvind.

Arvind: Okay. So the question was if one of your holdings such as fiat has grown significantly do you feel the need to sell down the position to manage the portfolio on occasion, so is that correct?

Audience Member: [inaudible 01:12:41].

Arvind: Even if in the future you think it's going to go up further.

Mohnish: Yeah, well, let me give you some real data. It doesn't make my stomach churn, but it might make your stomach churn a bit. So, one of my funds is the offshore fund, the PIF3, and PIF3 has about – I think about 240 odd million in assets. And about 40 plus percent or close to 40%, maybe 35 – I think it's about an $87 million position, is a company in India. So that's one position in that fund, so we got 240 million, let's say in assets and you might say let's say 90 million for example, it may be close to 90 million in this one company. Fiat isn't even the biggest of my problems, it's not the biggest holding in that fund. It has another 40 odd million of fiat, so I think maybe 45 million. So, you take this $240 million fund and you have a 135 million sitting in two stocks. And I think that if I look at India for example, for that fund, out of 240 million, a 135 million is in India, okay. And out of that 135 million, 90 million is one company. And my perspective on that is we are not going to cut the flowers and water the weeds. It is a very stupid gardener who cuts flowers and waters weeds.

[01:15:00]

So, I am actually going to address this to my investors in my next letter just so that they get some understanding that I haven't completely lost my mind. But the good news is that that fund, all the funds are closed. And so, why do we have 90 million in one stock? Well, we have 90 million in one stock because 30 months ago we put less than 11 million into it. And what am I supposed to do if it goes up 9x? And I am not going to sell it because it went up 9x. What I am going to do is first I am going to say, well done Mohnish, well done. The Indians would be proud of me if only, they had given me the cash and instead of their Chief Investment Officer, we'd be off to the races.

So, this particular company, when I first bought it, two and a half years ago, I thought we would probably get in five years somewhere between 5 and 10 times our money. That was my understanding in 2015 when I made the investment. And it's been only two and a half years and we are approaching 10 times. But, the thing is that the way it works in investing is you really learn the business after you own it. You don't really know the business when you are just analyzing it from the sidelines. And in the last two and a half years, I've actually spent a good bit of time trying to really understand the business. I had some good understanding of it I think before we invested, but I would say that understanding has gone up probably 3x or 4x since then because I've understood a lot more. This is one of the fun things about this business is the learning is never-ending. And the best I can tell is run by better people than I thought were running it, the moat is wider and deeper than I originally thought, and there's a number of tailwinds as far as the eye can see.

And so at this point, my take is that because the funds are closed and of course the people in that fund have done really well, I don't have this degree of concentration in the other funds because they didn't – it was a very small market cap, I couldn’t get that much money into it. We own pretty much the maximum we can own. And so, the thing is that if it goes down 20%, it really doesn't matter because it's the same set of investors. We don't have new money coming in or money going out – I mean, there might be some money going out, but we don't have new money coming in at these levels. So, for example, let's say, and I will just give a hypothetical number, let's say that fund is up 80% this year, what does it matter if next quarter it's down 20%? We are not concerned with the volatility. We are just concerned with the fact that I understand that business, I think that business has some lags, I think, if I were to sell and buy anything else, it would probably be inferior both regarding knowledge and regarding kind of return possibilities in the future.

Now, if we find other stuff that, if we find another 5x, and we don't have cash, and this thing looks like it's only going to double or something left in it, we might start trimming and do that. So, that's the best I can – so fiat 20%, that just bounces off me. 20% is nothing. When we get to 60% in a single stock, then I have to think about it. But even then I am not going to take action just because it's 60%.

Audience Member: So in your book, you mentioned that you trade off between [inaudible 01:19:39] and having higher [inaudible 01:19:41] volatility. Do you think that this capital allocation strategy that your fund employs is optimal for investors especially those of us that are young and are starting off just trading [inaudible 01:19:54].

[01:20:10]

Mohnish: Yeah, so one of the mistakes in my book is the whole discussion on Kelly formula. So, if I were to rewrite the book, I would not mention the Kelly formula. So the mistake I made in the book is that everything about the Kelly formula that I wrote is correct except that it only works when you get to do a zillion bets. So, if I am going to do a thousand coin tosses and I have 51% odds on heads and 49% on tails, and I keep betting heads, it's going to work out for me. But in the stock market, I don't get to do reported bets very frequently with very well-known odds. It's really infrequent. And so this was not clear to me when I wrote the book and so what I would suggest is that if you are reading the book, just ignore the entire section on Kelly formula, so my apologies.

The second thing is that I've never invested more than 10% of assets into a single stock. Usually, I like a 10 by 10 kind of, 10 bets at 10% or some bets at 5%, some bets at even 2%, just depending on conviction, but I am never willing and definitely with other people's money, I am never willing to go beyond 10%. And so I think there's a lot of research that shows that if you have a 10 or 15-stock portfolio, versus a 40-stock portfolio, you don't gain much in terms of diversification by going from 15 to 40, but you are going to give up a lot of performance by doing that, because you are not going to be able to come up with 40 ideas that are all undervalued and look great.

Audience Member: So my question is regarding kind of the economy right now, [inaudible 01:22:06] are pretty flat at historically less than the [inaudible 01:22:09] session. I was wondering if you are [inaudible 01:22:12] investment positions or how do you prepare yourself for a potential recession?

Mohnish: Yeah, I mean, I think that doing any of those things would violate the Bible. So, we have the commandments laid out by Buffett, Munger, and Graham. We are not going to violate those commandments. And one of those commandments is thou shall not fixate on macro, and thou shall not try to forecast recessions, and thou shall not short anything, and in general thou shall not hedge. So, those are the mantras. I mean, basically, I have no ability to forecast recessions, I have no idea what the economy is going to do, I have no idea what a lot of things are going to do. I think it's hard enough trying to figure out what a single business is going to do in the next two or three years, trying to overlay and figure out what complex economies and such are going to do is very hard. And I think what you want to do is good news with the stock market is that you can place bets where anything related to economy becomes irrelevant.

So, I will give you an example. A few years back, I think this is going back a long time, probably 15 years ago, I made an investment 15 or 16 years ago in a funeral services company called Stewart Enterprises. They've been acquired since then. Now they are part of Service Corp. and that's stock – but anyway, at the time I made the investment, it was trading at a PE of 2. And I subscribed to Value Line and one of the things I always like to look at every week is they have a listing of the lowest PE stocks. It's always kind of a fun list to look at. And usually, I've been looking at that list for I don't know 15 plus years. Usually, the lowest PE stock is a dog you don't want to touch. It's there for a lot of very good reasons like recently, we'd find Valiant in there for example. But even amongst the lowest of the lowest PEs, you hardly ever get to a PE of 2. I mean, a PE of 2 is you are going to make your money back in two years.

[01:25:00]

So, in 2002, I noticed this funeral services company which I'd never heard of before sitting at two times earnings. So, I just thought in my head that, hey, you know, the revenue of this company isn't going anywhere. I mean, I don't know, who's going to die in Peoria next year but I know how many are going to die in Peoria, Illinois next year. And the good news, the other thing I thought about at the time was that when your Uncle Fred passes away, you are not going to call 10 funeral homes and take the low bid, I hope you won't do that. What you are going to try to do is either go to one that has some history of the family or just make a call to someone who looks like – there's a decent operator on the other end. So, this is not a business where the lowest price operator is going to kill the higher price operator. And it's a recurring revenue business in the sense that it's franchise.

And the other thing about the funeral services business is, I can almost guarantee, no one in this room is aspiring to enter the funeral services industry. And so we don't have HBS grads or Boston College grads rushing into funeral homes to make that industry vastly more competitive and destroy the economics. That's not happening. And so when I looked at that, I was – all these thoughts were going through my head when I am looking at Stewart Enterprises at two times earnings. And of course I noticed suddenly, I was drooling as well. And so I wiped the drool off my face and decided to look into the business, and of course there were issues, there was hair on it, it had a lot of leverage and debt, but when I sifted through all the details, it was obvious that this was bulletproof.

So if you are concerned about a recession, why not look at Service Corp. Of course, the problem is that Service Corp. also used to be at $2 a share with earnings of $1. Now, of course, with the Dow 24000, last time I looked at Service Corp., it was at $37 at 17 times earnings or 15 times earnings or something. Everyone's really happy to own it. But no one wanted to own it when it was at two times earnings. So my take is that let's say for example today I had an investment in Stewart Enterprises at two times earnings, do you think I care that there's some recession coming? What would be the impact? And in fact, this is a funny thing, this is kind of the interesting thing about auction-driven markets. Right after 9/11, we had a major drop in stock prices. I mean, equity markets went down, we had airspace shutdown, all kinds of ugly things. Many of you guys were pretty young at the time, but Pabrai Funds was up and running at the time and so very clear memories of all kinds of ugly things going on there.

And I looked at the stock chart for Stewart Enterprises during the period of September to December 2001. Now, as morbid as this may be, if anything, the prospects of that business went up after 9/11. If you are burying dead people and people are concerned about the escalation of terrorist attacks, you should be going all into Stewart Enterprises stock. I mean, that's going to rally. It tanked with everything else. And so you explain that to me, so this is the fun part of the equity markets. It took Stewart Enterprises down along with United Airlines. Now United Airlines went down for a really good reason. I mean, their planes were used to go into the World Trade Center, airspace was shut down, all kinds of things were going on which should have led to United's stock price going down a lot. But why should Stewart Enterprises' stock price have gone down at that time? And this is the nature of auction-driven markets.

[01:30:00]

So what I would say is that it is not that hard – if you have a concern about recessions or whatever, there are ways going long stocks to play that while retaining upside without really having much of a downside. You just have to dig and find those things.

Audience Member: It's said that a lot of investing is looking under rocks and seeing which ones a good [inaudible 01:30:29] under them. How do you choose that sort of base level what rocks I actually look under, [inaudible 01:30:35] all the analysts looking under a bunch of that and just see numbers.

Mohnish: Yeah. Well, that's a very good question. So, I was finding it difficult to find rocks with anything and then them. And I think in the last two-three years, the best source of ideas for me has been emails from Joe Public. So every day when I go to work, at 11 AM, my assistant gives me a folder with all the emails that have come in for the day. Unlike most of you, my emails don't come to me. They go to my assistant, they get printed out, they get put in a folder and I get that folder at 11 o'clock, I get that folder with any bills or wires or anything I got to deal with. And by 11:15 I am done with the folder, and so it's about 15 minutes of dealing with emails. And Joe Public is really benevolent and nice to me. So Joe Public sends me interesting ideas.

So, I mentioned that I have this 9x on this stock in India. Well, that was Joe Public. Thank you, Joe Public. And in fact, his name was Parry Pasricha, I still haven't ever talked to him, I've never met him. One of the most elegant analyses of any analyses I've ever received was analysis Parry Pasricha sent me. And now we have, I don't know, 170 million in gains and counting just because parry decided to be benevolent and send me an email. Thank you so much, Parry. And so the rocks I am looking under, I just rely on you guys man, you guys you know I don't get no analyst, I got no payroll, I got nothing man, I am dependent on you. So I am totally depending on you sending me the 10 baggers. Please make sure, you send them and I am eternally grateful.

And so I think – and what I decided to do in India was that in India I just decided that I am going to go every six weeks or eight weeks, I am going to spend Monday through Friday, I want to try to see three to five companies in a day. I don't care what they do, I don't care what their earnings are, I don't care what the multiple is, I don't care what the industry is. I just want to learn. And so, basically, I meet about 10 to 15 companies a week when I am there – and every six or eight weeks I keep doing that, and it is an incredible amount of data and info that comes in. And through that – and I haven't been doing it for that long, I've only been doing it for like a little over – about a year basically. And already we found a whole bunch of stuff that there was a misunderstanding or things – people didn't understand things. And one of the things – I have disadvantages in India because I am not there, but I have advantages too because I can take a bird's eye view that local market participants sometimes have difficulty with. And sometimes I can overlay things that I've learned in the decades of investing which have given me some mental models that people aren't able to overlay when they are looking for a particular investment. So some of those things kind of help out and such. So right now basically, the modes operandi is to get on an airplane, meet 10 or 15 companies, drill down, see if there's any meat on the bone and then just keep doing that.

[01:35:00]

Audience Member: Interesting to hear your take on passive investing. Honestly, you have very [inaudible 01:35:08] costs but do you think that over the next decade or so, we'd be able to [inaudible 01:35:15] rate of return or compound the [inaudible 01:35:18] rates of return by investing in the broad global markets?

Mohnish: I think that globally you have something like 50,000 stocks and these are 50,000 entities straight in an auction-driven manner. By definition, they cannot all be efficiently priced. I mean, markets gyrate with fear and greed. I mean, I will just give a very simple example, let's say for example, I own a town home in Boston. And let's say for example I bought that town home for a million dollars. And let's say I have a knowledgeable realtor who's a good friend of mine. And I tell that knowledgeable realtor, listen, I want you to show up every day to have coffee with me and I want you just to tell me what my place is worth every day, okay. First of all, he's going to think you are an idiot for asking him to do that, but let's ignore that for a second.

And so, you bought the place for a million. Next day you meet the guy for coffee. You ask him, hey, what's my place worth. He says, listen, idiot, it's still worth a million. And then two days later, you ask him the same question again. He's going to say, it's still worth a million man. And then you know, three months go by, and he's going to say – he's getting tired of these coffees, and he's going to say, you are lucky, market's moved up about a percent, so I am seeing transactions about 1% higher than where you were or half a percent higher or something. And then again, you are irritating him every day by asking him the same thing. He doesn't have much to do and in the course of a year, if you just plot the number he gives you every day, I mean, it'd be hard for you to have a range which would be more than 950,000 to like 1.15 million at the outer end, maybe even tighter than that. You might be at 1 million to 1.1 million for example or even 5% range in a year, a very tight range.

Now, if the townhome were listed on the New York Stock Exchange, and every six seconds the price is changing, I can assure you that the range on that in a year would be something like 700,000 to 1.3 million. It would be a much wider range than what your intelligent broker gave you. And the reason for that is your intelligent broker is looking at valuations in an intelligent manner and auction-driven markets, by their very nature just aren't that efficient. I just gave you the example of Stewart Enterprises. I mean, there is no reason under the sun it should have traded at two times earnings, there's no reason under the sun it should have gone down after 9/11, it should have gone up or at least stayed flat, but it went down with everything else. And so markets paint things with a wide brush, so if we have let's say a paint company, let's say Axalta you know [inaudible 01:38:55] from DuPont. They have a bad quarter for some reason, a lot of companies have, one quarter means nothing in the life of most companies. They [inaudible 01:39:05] taken out back and shot because they had a bad quarter and no one's going to care about hey let's look at this over 5 or 10 years. And because of that nuance, you are always going to have under pricing or over pricing of equities, almost everywhere, in almost every stock. I mean, if I look at the stock price of Amazon, Amazon's stock price or any company stock price, is supposed to reflect the sum of future cash it's going to produce from now till the time the company is gone, discounted to present value by some reasonable rate of interest. So what cash is Amazon going to produce? So first question – when is Amazon going to be gone?

[01:40:00]

No idea. I don't think any analyst has any idea when Amazon is no longer on planet earth. We don't know when that is. Then the second question – what are its cash flows every year from 2018, let's take a hypothetical case, let's say Amazon in 2045 ceases to exist. So from 2018 to 2045, what are its cash flows? I don't have the foggiest idea and I would even go one step further and say I don't think anyone else including Bezos has the foggiest idea what those numbers are. And without knowing all those numbers, somehow the market has ascribed a price to Amazon. It's come up with a very precise number, down to the penny of what that business is worth. Now, the odds that the market has precisely figured it out, it is as close to zero as you can possibly imagine.

So what is my reaction to Amazon? Well, if I know what they are going to produce from 2018 to 2045 and I can discount that back, then I can tell you whether to buy it or not. But my answer to Amazon is taking a pass, I have no idea. But when I look at Stewart Enterprises at two times earnings, I just got to ask myself a question. Are humans going to die this year? Yes. Are humans going to die next year? Yes. After two years of humans dying, will we have earned in earnings what is equal to the price of the stock? Yes. Okay, so then let's buy the stock, let's hold it for two years, let's ring the register so that now price is equal to earnings and we've already cashed the two years and now let's see if in the third year humans are going to continue dying. That's all I have to do with Stewart Enterprises. I didn't have to know whether humans are going to die in the third year and whether we suddenly become immortal. I just had to know that they were going to die for at least two years. That's it. And so that's what you want to do in investing is you want to pick out of the 50,000, the ones that you can explain to a five-year-old or an eight-year-old without losing their attention in two minutes or less. And then if you can do that, then you make the investment.

Audience Member: Mohnish, thus far, you've touched on a broad array of topics. I just want to explore one or two of them thus far, which is you talk a lot about this long-term mentality, to be successful over the long term your subject to your investor base. So how do you ensure that they have a similar mentality to you? How do you go about evaluating them? And then the second piece is you talk about not taking the macro risk in the portfolio and the like. At different moments in time you've raised cash and yet you didn't necessarily put that to work day one, so inherently you are taking some macro risk or some drag from that. How do you think about that?

Mohnish: Yeah, so, let's go back to the book which said how to make a $1000. The thing is, we don't need to really be concerned – I've never been concerned about redemptions, I've never been concerned about LPs, I think it's only been twice in 18 years when I've actually picked up the phone, called an investor and told them, look, I think it's not a good idea to redeem. In both cases, they were institutions because most of my investors are individuals, high net worth individuals. They were institutions, they were taking out large amounts of money. I was okay. I could deal with it, but I felt that they were taking it out at one of the worst possible times. And I tried to impress upon them not to do it, and I failed, they took the money anyway. And so, I think it was the right thing for me to do in that case, but generally I am not a proponent of ever telling people not to take their money. I think they should take the money whenever they want to.

[01:45:00]

So I've never been concerned ever about redemptions, and the reason is that the kid at 11 who was trying to figure out how to make 1000, didn't know what a hedge fund is, didn't know what an LP was, he was just looking to compound his own capital. And the good news is I've got slightly more than a $1000 now, and I can compound that capital with 0 LPs. So if I have LPs, [inaudible 01:45:35] my partners, it's a really great group, I like the group, they are mostly first generation entrepreneurs, made money themselves and all that, it's kind of a fun group, I like the group, they are good guys, good families all over the world. But if every one of them took away the money, it's not a problem. I never banked on it in the first place. And so I am happy managing their money, managing – being a fiduciary for them and all of that. But if in the future they decide I am not the right guy and like for example, I am going to lay out for them that we've got this two-thirds of assets in two businesses in companies that they probably are not thinking is the next Google, and some of them may think that okay I've had a good ride with Pabrai Funds, but I think I want to get off the bus. That's perfectly fine if you want to get off the bus, no problem.

And so I think that managers should just ignore redemptions or volatility or any of those things which could lead to a flight of capital. I think it's just a wrong way to think about it. I think you just want to focus on doing the best job you can and you invest the money. I am – like for example, the Fund 3, if I could – Fund 3 is the only fund that I can't put money in because it's an offshore fund and as a US resident I am not allowed to put money in that fund. The other funds don't have the same concentration. If I could, I would put every penny of Pabrai family assets into Fund 3 out of all the funds I have. I think that is the place I want to be, with those concentrations, because when I look at the future, I don't think any of the other funds can hold a candle to what that fund's going to do. So, if I had a choice, that's where I'd put it. I don't have that choice. Such is life.

So, the thing is that I am not concerned about volatility, and I am not concerned about people leaving. None of those – I think it's a privilege that they are with me; if they leave, I am still going to be happy, I am still going to be talking to your class if you allow me to come back with zero assets under management. And then they...

Audience Member: [inaudible 01:48:21] assets Mohnish, we are grateful to have you every year.

Mohnish: What was your – you had a second part to that question [inaudible 01:48:30]

Audience Member: Yeah, the second Mohnish is you were talking about the Buffett, Munger, Ben Graham rules and avoiding macro risk and bottoms-up and so on and so forth. And at different moments in time, I think relatively recently, you've raised money to put to work in the funds, most of the time they are closed but sometimes investors are blessed to get this window to invest with you. And inherently, by having maybe 30% or 40% of the funds in cash, when you are raising money, pro forma of that inflow, you are taking timing risk in some shape or form. How do we think about that?

Mohnish: Yeah, but I don't think about it that way. I think you got to think about it regarding a business. I mean, drag, whatever, I don't care about the drag.

Audience Member: Right. So you will wait for the no-brainer?

Mohnish: Yeah, we started two funds. We just started the India Focus Fund. There are the US and an offshore variant. By definition, it's going to take time to put that money to work. I think it's sitting in significant cash position – irrelevant.

[01:50:00]

I mean, so what, we may have some impact on performance, maybe for a year or two. Eventually, we are going to find places for the money to work.

Audience Member: Right. I hadn't heard you address that before, so there was a question on the list, I thought of.

Mohnish: Yeah, so, I mean, I think you just, you know, the best way to think about all of these things is if your family had a fortune of a 100 million and you were entrusted to invest the 100 million, I think very few of you will look into get a 100% in the market in one day, unless you are buying and index and willing to hold that for a long time. If you were going to pick stocks, who cares if it takes you three years or five years to find all the stocks you need to put the money to work.

Audience Member: Right.

Audience Member: Mohnish what is your opinion on purchasing an insurance operation or managing another business with [inaudible 01:51:04] capital.

Mohnish: Arvind can you just repeat the question?

Arvind: Sure. The question is Mohnish, what is your opinion of managing an insurance flow or a vehicle that would give you more permanent capital.

Mohnish: Yeah, so, I bought an insurance company about three years ago, and it's a good company, good people, but it was a mistake. And thankfully we reached an agreement to sell the business, it hasn't closed yet but it's going to close soon, and it'd probably be a good asset for the buyer, but I have learned that it's a difficult business and I used to have delusions about the wonders of the float. All those delusions have been washed away, and so, I don't think I will be entering the insurance business again in this lifetime. I would like to enter the funeral services business though; at one time's earnings, that would be great.

Arvind: Perfect.

Audience Member: Well, I wanted to say thank you for answering the [inaudible 01:52:40] I really enjoyed reading your book from a philosophical perspective [inaudible 01:52:47] still an entrepreneur, how does that impact how you view management teams?

Arvind: I can repeat the question.

Mohnish: Yeah, please.

Arvind: So the question started with firstly, thank you for writing your book, it's wonderful and very illuminating. And then, the question was, as an entrepreneur and former entrepreneur, how does that influence your interaction and learnings from management teams?

Mohnish: Yeah, I think it's a huge advantage to have run a business before and even Pabrai Funds is to some extent a business, but it's a huge advantage to have done that. I think Buffett has a quote, he says, "How are you going to explain to a fish what it is like to walk on land?" And he said that looking at businesses and running a business, is the same difference between trying to explain to a fish how to walk on land and actually walk on land. So, it is a huge advantage, and the good news about this is the scale doesn't matter. So, it was very important for Warren to run the Wilson Coin Operated Company. It didn't matter that revenues never even hit a 100,000 or a million. That is completely irrelevant. So there are two factors, one is that the way our brains are wired, we gain a huge amount of advantage if we get exposure to running businesses during our teen years, specifically between the age of about 11 or 12 to about 20 or 21. That window of time is when the brain is set up to specialize.

[01:55:00]

And in our modern society, in that window of time, we are asked to be a jack of all trades, take classes in all kinds of subjects and all of that, and by the time we start specializing, that window is closed. So if you study people like Gates or Buffett or Leonardo da Vinci or a whole bunch of other people, you will find that they had some very amazing experiences during that 11 to 20 or 22 periods, and if they didn't have that experience in that period, we wouldn’t have heard of them. And so, – but, better late than never, so, for all of you in the classroom, obviously that window is gone, but you can still learn, it's not going to be as efficient you can definitely still learn. And so I would say that even if it's a Mickey Mouse business, some small thing you are doing somewhere, I just think you are going to learn a lot. You learn an incredible amount by [inaudible 01:56:06] by paying rent, by negotiating a lease, a hundred other things. And so, I think that the scale is unimportant, but being in the trenches and especially if you are blessed, and the business fails, then the learning is exponential. So I hope all of you try to start businesses or run businesses and I hope you fail because then that will sow the seeds of greater success down the road.

Audience Member: Yeah, Mohnish, you've got a lot of experience and success in investing and buying commodity-based businesses, I am wondering what sort of mental models or skills you have that a lot of other value investors particularly guys here [inaudible 01:56:56] area don't have?

Mohnish: Well, I think commodity-based businesses can have moats. The single greatest moat a commodity-based business can have is being the lowest cost producer. So, if you have two ingredients in a commodity producer, one is they are at the bottom end of the cost curve and the second is that they don't have leverage, this is money in the bank, especially if you can get it at low valuations. So, if you were to own the oil fields of Saudi Arabia where you are bringing up oil at $2 a barrel, and you are selling it for 60, that's a really good business. If you were to own the iron ore fields in Pilbara region of Australia, where you just scoop up earth and just transport it to a port and then send it to China and they pay you for the iron ore surface mining, it's a great business.

So, there are many commodity businesses that are really good [inaudible 01:58:22] in any environment, and we've seen that. I mean, they built the whole economy on that. And so if you got iron ore reserves in Brazil, if you've got just low-cost reserves and low-cost operations, putting you at the lowest end of the cost curve, no leverage and a purchase price which is very low because the world is not interested, so usually for example, let's say, for example, some commodity price collapses, let's say iron ore price collapse or oil prices collapse, etc. At that point, the best thing to do is to focus on these attributes. So, on one end you can buy for example things like the oil fields in Saudi Arabia, on the other hand, you can buy offshore oil being sourced, offshore in the North Sea and so on, where the cost to bring it up maybe north of $60 a barrel. So there are many choices you have, and so you are better off staying away from the high-cost producers even when they achieve, and you are better off focusing on the low-cost producers.

[02:00:00]

And so, for example, one of the reasons we've done well with this company in India which has given us 9x so far is that there is a moat, it's kind of difficult to understand the moat in that business easily, but they are the lowest cost producers in the market they serve. And so that gives them a huge tailwind and that tailwind is enduring for a long time.

Audience Member: Well, finding simple businesses with durable moats in distressed industries would obviously be an ideal investment situation, something you already kind of alluded to that there's a very large number of investors, globally searching for those exact investment opportunities, which can result in a limited number of companies that do meet all the criteria, you outlined as for framework in your book. So which of those factors are you willing to compromise on and which ones you consider deal breakers?

Mohnish: Yeah, that's a good question. So actually, there's a guy Eli Broad, he's a billionaire, he's made money in multiple industries, he was a founder of KB Home amongst other companies, and he wrote a very nice book, it's called the Art of Being Unreasonable, and it's a great book, I love that book. And that's what you want to be in equity markets. You want to be extremely unreasonable. And so, there's no need to compromise, because you always have the choice of just sitting on cash. And so I think the nature of equity markets is that people vacillate between fear and greed and there's a large number of businesses around the world that are in these auction-driven markets, things are going to show up. And I think for example, if you focus on looking at places like Value Investors Club or Sum Zero or any number of these forums where the value crowd hangs out and just read some of the highest rated ideas and such, you are going to find stuff from time to time that's going to intrigue you. And if you don't, it's not the end of the world, just keep reading, only act when all ducks line up. This is not a business where you need to compromise.

Audience Member: With your background in the tech area, what're your insights on how technology is affecting new investments and what do you see as the future of technology in investment?

Mohnish: I don't think it's going to change – I mean, I think – let's put it this way, we are seeing a movement towards passive investing, we are seeing more assets going into – and in general, that's really good news for stock pickers. The more drones there are in the market, the better off we are because the lemmings are going to act a certain way, and some things are going to get overpriced and something going to get underpriced. So, I would say that I don't see technology have a particular – the thing with investing is its part art, part science. You could perhaps see AI come in at some point. I just think that point is quite far away because again, you'd have to blend a lot of different things into the AI if you will. So at least in the foreseeable future, I don't see technology being a deterrent, and I actually think we've got tailwinds because we've got a movement to indexing.

Audience Member: You've spent a lot of time with Charlie Munger, I was wondering sort of what's your biggest takeaway of things having met him personally [inaudible 02:04:35] but people who don't [inaudible 02:04:37] something like that.

Mohnish: Arvind could you repeat that please?

Arvind: Yeah. So, being friends with Charlie Munger, what do you think is the most surprising and most misunderstood about him?

[02:05:00]

Mohnish: Well, I think Charlie is just if you just completely ignore inviting, he's just an amazing, incredible human being, very, very high quality. And we see – I mean, anything I can see in interactions that are one-on-one, is not that different from the interactions we see at the Berkshire meetings and so on. And obviously very high-quality person and he's surrounded himself with some really high-quality people, his friends and such. So, I think he's the great role model, and I think he's – most of the lessons you would want to learn from both Warren and Charlie, are easy to grasp without knowing them because there's so much in the public domain. So, I think that Charlie had mentioned, I think last year or the time before that at the daily journal meeting that he had made an investment in 2002, I think it was a company Tenneco, and he had done 8x or something on it in two or three years. So the 10 million became 80 million, and then he gave that 80 million to Li Lu which I think now maybe, I don't know, I am guessing, north of 500 or 700 million or something.

And so if you think about it, from 2002 to 2017, a 15-year period, he did something like a 70x or 80x on an investment, and on a significant amount of capital, 10 million, in the sense that – so if some of us had let's say a $100,000 for example, we won't have as much restriction on how or where that could be invested. But I didn't do as well in that period, and I brought it up to Charlie. I, actually recently when I met him, I said, "Hey, you know Charlie, I think a lot about that 80x, that was pretty cool." And then he just said, "It only happened once in my life." He said, it just happened once. So what he was basically saying is that in 93 years and he's going to be 94 in another month – in 94 years one time, there was this 15-year period, where he did a 70x. But the thing is that we don't need too many of those. Even if we get one or two of those types of things, in a lifetime – and so I like to think of that as what I call the slingshot, or I am not sure what the correct word for it is, but I think that it's a two-step, right. So, one way you can get the 80x is by just finding Jeff Bezos early and figuring out long-term cash flows coming out of Amazon. So too one way you can get 100x or whatever.

Another way to do it is the Munger way, which is the two-step, and the two-step is not easy because if I want to do 100x, I need two 10xs back to back. But the thing is that if you were going to scan the horizon, in his case, he read Barron's for 50 years, did nothing and then acted once on one particular article in Barron's out of 2500 issues with each issue having at least 10 stock tips. So, out of 2500 stock tips coming at him, he's swung at just one. And then out of all the people he could have given money to manage, he picked just one, and in both cases he was right. But he didn't make those decisions three times a year. He's picked a money manager once in a 94-year life, and he picked his stock to buy once out of 50 years of reading Barron's.

[02:10:00]

So the shooting fish in a barrel, especially when the water has drained out, does happen in equity markets, and many times it's happened to me where I should have put a bucket out, to collect the rain when there's a downpour, and I put a thimble out, right when it's raining gold and such. So, I made that mistake many times. Or it's raining gold, I collect it, but then I sell it, that's happened a lot. So I am trying to learn not to sell early, and I am also trying to learn not to buy an insignificant amount. So, there's a lot of lessons from Munger. I think the best thing is to just read Poor Charlie's Almanack, I think that's just a great book. And I try to reread it every year; and every time I reread it, I could swear, I found things in there that I never read before. So it's great.

Audience Member: Yeah, you and your wife had the Dakshana foundation. How different are choosing places in like non-profit world and charity world? How different is choosing places to invest there from choosing places to invest for returns?

Mohnish: Yeah, so, it's been a lot of fun, Dakshana just finished 10 years, which is great. I think it's more difficult to give money away effectively than to make it. I think if you are looking for high social returns on invested capital if you will, that's a good thing to aspire to, and it's a good thing to try to measure, but the non-profit world is a very different world than the for-profit world. So, we were lucky with Dakshana in the sense that, we were able to find a model that offered a number of things, it offered very precise measurements of input versus output, and it offered very high returns and measurable returns on what was going in, which – there are many, many endeavors in the non-profit world that are worthwhile doing but where measurements are very hard.

And so, what my wife and I did was we flipped the problem, we basically said – we inverted the problem, we said that we are going to ignore every endeavor that makes sense if the measurements are hard, because we have limited amounts of kind of arrows in the quiver if you will, so we can be choosy. But if we pick up – if you pick an endeavor where measurement is hard, then we wouldn't know whether we are succeeding or failing. And so, a market system, in the for-profit world has a very tight feedback loop. If you start a business and that business does not produce cash, eventually you are going to be out of business, and the market system will eliminate businesses that are not self-sustaining.

But in the non-profit world, if I am for example, giving away 2% of my wealth every year, that can continue forever, regardless of whether the endeavor is going into is any good or not. So, there are no signals, automatic signals that come out of the non-profit world that will allow you to course correct. In the for-profit world, you are going to get signals to course correct. If you ignore those signals, you will go out of business. So there's very kind of direct impacts of not doing course corrections. One of the issues that we are going to face is that the endeavor that we are involved with works really well, but it can take a finite amount of capital. I think, once we get past 4 million or 5 million a year, we cannot put any more capital into that endeavor, we'd run out of brains basically. And so after that, I don't know what we, will do. We will try to find the next highest endeavor. We might have to let the cash pile up while we are trying to do that or we might find that we need to compromise a bit and lower the returns and go for it. So, I don't know. We haven't reached those points yet.

[02:15:00]

And so the non-profit world is more challenging, but I think, the intangible rewards are a lot higher. I mean, I think my life would be far less interesting – in fact, I think, I might say that it'd be a much lower quality of life if there weren't the Dakshana. So I am very grateful it's there, I am very grateful we found a cause that worked, I am very grateful there's a great team. We've scaled up – and also, so far we haven't hit that point, we are going to hit that point soon I think, thanks to Rain Industries, and Sergio Marchionne at Fiat that we need to find the next endeavor which would be great. It'd be a good challenge.

Audience Member: Mohnish and more, I think obviously because we've had – I guess, that's [inaudible 02:15:50] go it alone mentality, you have [inaudible 02:15:53] own shop and you discussed a little bit about [inaudible 02:16:00] you don't want to be looking at stocks all the time, you don't want these analysts and you also kind of [inaudible 02:16:03] and getting Joe Public to come give you information. With all that in mind, do you think that value investing and investing somebody can do an [inaudible 02:16:14] full-time job, so that with [inaudible 02:16:17] we need to have [inaudible 02:16:21] I am checking my portfolio, every once in a while and [inaudible 02:16:24].

Mohnish: Arvind, I am sorry, can you repeat that?

Arvind: Yeah. The question was for the most part or not, for the most part, you are completely independent regarding idea generation, waiting for the 10 baggers with benefiting from Joe Public and Sum Zero and the deck, etc. do you think someone can just do this as a part-time job?

Mohnish: In fact, I think it's a negative to do it full time. I think, again, because you are going to have more activity. There's a radiation oncologist friend of mine. Actually he was my college roommate, and I tell him, he's confused about what his calling in life is because he's so excited about value investing and sometimes he'll call me in the daytime, and I am saying, I hope someone doesn't have some radiation going on right now while you are shooting the breeze with me here on this stock or that stock or whatever else. And he's done really well, actually incredibly well. I mean, he makes a lot of money as an oncologist but I think he's earnings on the investment side and the growth of net worth dwarfs what's happening on the oncology side. And so I tell him, I'd say, and he agrees that oncology at this point is mostly a hobby for him. But he doesn't have that much time. I think he might have maybe 10-15 hours a week, and for many years I was a part-time investor because I was running another business like '95 to '99. So it is not a disadvantage to be part-time. In fact, I think it's an advantage because you have less of a reason to act and such. So, you can be even more patient and such. So I think, it's an advantage to be part-time.

Arvind: Mohnish, we are so grateful for the time. Maybe we can end with just any closing piece of advance that you may have for the students that you want to share or if you don't have any that's totally fine as well.

Mohnish: Well, I would just say that I was very excited to do this talk and I was very excited to share with you the simple concepts of the Rule of 72, runway, starting capital, the annual rate of return and all those kind of things and playing with those numbers. And I think having fluency in that and more importantly, it doesn't even matter if you go into that area, but I would say that just what I started with, which is that you just have to take a simple idea, but you have to take it very seriously, and you have to become obsessive about it, very intensely obsessive. And thank you very much, Arvind.