My interpretation of 10 commandments of investing management by Mohnish Pabrai

Mohnish Pabrai is one of my favourite value investors.  He shared a relationship with Warren Buffett and Charlie Munger from Berkshire Harthaway.  $BRK.B, $BRK.A.

Mohnish Pabrai

Pabrai Funds portfolio as of Q4/2021

This was the collection of his 10 commandments coming to investing.  The source was https://www.gurufocus.com/news/753022/mohnish-pabrai-talks-about-the-10-commandments-of-investing and I have added my own thoughts in red italic fonts.

Thou shall not skim off the top

Pabrai thinks the fee structure in wealth and asset management is wrong. Most money managers are sinners. He takes issue with the fixed fee on assets under management. He specifically highlighted some original practitioners, Warren Buffett, who ran a 0/6/25 structure, and Munger, who ran a 0/33 type of structure. That means a 0% management fee and either 25% above a 6% hurdle or a 33% fee above a 0% hurdle.

Personally, we should be rewarded with after delivered "agreed" results. There are many fund managers who made money for themselves instead of the clients when they make many short term trades.  They were more interested in earning commissions for themselves instead of making money for their clients.  This is something that we need to look out for.  Thus, I have decided to put aside time and resources to research the companies and market.

Thou shall not have an investment team

Investment management is not a team sport. Any two humans are going to have different circles of competence. For a good investment manager it doesn't make sense to have analysts. After listening to Pabrai, it still seems possible to have analysts but it takes a lot of work to get into a good working relationship.

While investment is not really a team sport, I do see the benefits of having a community that share similar values.  As we have different circles of competence, risk-reward tolerance, investment timeline, no 2 investors are the same.  However, it is known that Li Lu helped Buffett and Munger to venture into the China market, making good returns from their returns in BYD.  Guy Spier and Mohnish Pabrai would also share their thoughts with each other coming to investing.  They may not arrive at the same conclusion or invest with similar "capital allocation %" but having good counsel is a good margin of safety in my context. 

We do not take another's words without doing our own due diligence as we cannot invest based on borrowed convictions.  We need to establish our own valuation, entry and exit strategy accordingly.

Thou shall accept I shall be wrong one-third of the time

Investing is a very inexact science. It is very difficult to figure out what will happen to a business years from now. Four out of 10 will not behave in the future at all like you expected at the time you made the investment.

We will not get all the trades right despite the best of efforts.  The key is for us to learn and get better. This is definitely the case as we are unable to predict various macro events like the Covid pandemic, the recent Ukraine crisis, other geopolitical events and natural disasters.  

Investments are made with researched assumptions.  As assumptions are not foresight, we will need the future earnings and business performance to back our analysis.  Let us be happy to admit our wrong so that we can direct our resources to better assets. 

Thou shall look for hidden 1x price-earnings stocks

You should look for stocks based on future earnings or hidden earnings that are trading at a 1x multiple. These can’t show in a screen because they're not hidden, and they most likely wouldn't be good opportunities. When you can buy at this valuation good things tend to happen.

PE is a good way to start to screen for stocks.  However, Pabrai has also mentioned recently during the interview with "everything money" that Tesla may not be overvalued.  It is just "too complex" and he does not understand the business well enough for him to "value the business".  While PE is a good screen, we could miss out on other good opportunities too.  As such, I am adding considerations such as FCF, Enterprise value (as per Michael Burry) with PE being inappropriate as the only indicator for some industries.  I do not think that there is a "perfect" screening tool but we do need to move within our "circle of competence".  This is something that can be enlarged over time - just look at Berkshire buying Apple ($AAPL).

Thou shall never use Excel

This commandment goes hand in hand with commandments before. If you need Excel to figure out if something is a great investment, it can’t be a great investment. If you need Excel, you need to take a pass. Buffett has said something similar about figuring out investments on the back of a napkin.

I do agree that the calculations and valuations should not be too difficult.  However, I am also happy to leverage any tools, including excel as my biggest ROI is not just money, but time.  If there can be better tools to free up my time, it would be something I would gladly consider.  I do not need  "Iron Man" state of the art technology to work out valuations but I am happy for technology to assist.

Thou shall always have a rope to climb out of the deepest well

Pabrai’s dad was very good at starting businesses. But his dad would always run them very aggressively. He used a fortune teller to give him the confidence to pick back up after a bankruptcy. Setbacks are part of the course, but you need a way to deal with them.

There is always a chance to be and do better.  I have learnt that all things that happened in life as blessings or lessons.  It would be a shame if we could not "get more value" from the failures we experienced.  No one will have a perfect track record in life, in investments.  It is a lifelong journey to learn, unlearn and discover oneself.

Thou shall be singularly focused

Only focus on the company. You should not care about the macro or anything else. Focus on the business and close out the noise.

We are investing in businesses, not just a stock ticker like $BRK.B.  In this case, the business fundamentals are crucial so that the business has the right management, competitive advantage backed by good financial fundamentals.  What happens in the market is separated from the company.

Thou shall never short

We don’t need to figure out what will happen to Tesla (TSLA, Financial). Tesla is entertainment to Pabrai, and he likes it that way. He said that he will go to his grave without ever having shorted a stock. The risk/return profile is asymmetrical. Shorts can at most deliver a double but move against you many times.

Shorting a business is to make gains from the failure of another.  Ideally, I do not wish to make money from the failure of another.  There are limited to gains in shorting but unlimited in losses - a risk/return ratio that is against the one who short. 

Thou shall not be leveraged. Neither a long-term lender nor a short-term borrower be

You don’t want leverage in your life. To finish first you need first finish. The key is to spend less than you earn. Put that in a compounding engine. Pabrai hammered home the importance of not blowing up. If you compound at a stellar rate but you follow a string of winning years with a single zero, you have compounded at 0%.

Invest with what you can afford to lose.  Invest without putting family's livelihood at stake.  Easy money & over-leveraging is the best recipe for trouble.

These are some of my favourite quotes from Mr Buffett and Mr Munger concerning leverage:

“If you’re smart you don’t need leverage; if you’re dumb, it will ruin you.”

It is crazy in my view to borrow money on securities. It’s insane to risk what you have and need for something you don’t really need… You will not be way happier if you double your net worth.

As much as time compounds the values of assets, it will likewise compound interest when we take on leverages.  We would be pressured to make money to cover the interest, causing us to work as if candle is burning at both ends.   

Thou shall be a shameless cloner

Cloning is good for your health. There are many great investors. Look at their highest conviction ideas. This is a shortcut that works, and it helps with other commandments like not hiring analysts. 

There is no issue with cloning so long you have done your homework.  If we are looking at 13F for entry and exit, it can be too late.  Using $BABA as an example, Mohnish sold off most of his $BABA positions while Charlie Munger doubled down on his in 2021.  If we are following both gurus, should we sell or hold?  

Having done my research in Alibaba, I plan to continue to add to my holdings.  There is one reason to buy and millions to sell.  Thus, I cannot stress enough the importance for us to do our own fundamental analysis.  We cannot invest on borrowed convictions.

Video link

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