Here’s a great recent video of Mohnish Pabrai’s presentation at the Peking University (Guanghua School of Management) in December, 2017.
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The presentation is full of a number of value investing insights but there’s one part in particular in which Pabrai provides a great example on how investing can be made much simpler if you’re patient and wait for opportunities. While at the same time reducing your risk by staying within your circle of competence.
Here’s an excerpt from the presentation:
We have to do what I would call anomalies, we have to look for strange things that show up once in a while. They don’t show up all the time. We have to be scanning the horizon and doing that, once in a while something will show up that makes a lot of sense, and then you act on it.
I’ll give you an example. A few years back someone sent me a write-up on a steel company. The kind of economics of this company was that the stock price was I think around $40 a share or $45 a share. They had $15 a share in cash, no debt, and they have contracts where their earnings are $15 a share for the next two years.
So between the cash and the next two years of earnings you’re paying $45 you get the $45 back in two years. But you still have the company or the plants and everything else. After two years there’s no visibility into what’s gonna happen. It’s a cyclical business, so I said okay we’re going to make the investment. We’re going to keep it for two years and see what happens. Because I take in the cash and at that point I got all the cash back so I bought the company for $45.
One year goes by and they say another two years [earnings] at $15 a share. So one more year is set. The stock is now at $75. So now it’s $60 for $15 [cash] plus three years [earnings at $15 a share] equals $60. We are now above our cost. Then they announced one more year $15 [a share earnings]. Now the stock is at $90. It’s doubled and then I’m thinking I should sell and whatnot, then they announce someone is buying them for $150. I don’t even wait for the deal to close. The stock goes to $150. I sell it. So I don’t need a lot of horsepower to figure that out. It was easy to figure out but it doesn’t happen every day.
Charlie Munger says, there’s a friend of his. He’s a billionaire. He lives near Stanford University. John Arriaga only invests in real estate within one mile of Stanford University. From having no money forty years ago he’s a billionaire.
All he did was he never put on a lot of debt and when things went down he bought and when everyone got euphoric be sold. That’s all he did. What is John Arriaga’s circle of competence? Is it real estate? No! Is it U.S real estate? No! Is it California real estate? No! Northern California real estate? No! Only real estate around Stanford. His circle of competence is this small.
The good thing about getting wealthy is we don’t need to understand a lot of things!
You can watch the entire presentation here:
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Article by Johnny Hopkins, The Acquirer's Multiple