Mohnish Pabrai

Q&A : Dhandho Holdings and Pabrai Funds Annual Meeting – 2015


Dear Readers,
Listening to Pabrai, who is ardent follower of Warren Buffet is itself a treat for me.
Hope, these question answer session would remind you about Berkshire Hathaway Q&A session…

Questions & Answers

1. Consumers in U.S have stretched their replacement cycle for automobiles from 7 to 11 years. Can you please share your thoughts on demand for automobiles/cars in U.S and its implication to companies like GM and Chrysler ?

(Pabrai) The demand for cars in U.S should grow along with the population, unless there is a change in consumer behavior ( for example Uber changes the way we commute and travel ). On Average the auto sales has ranged between 15 to 18 million vehicles per year expect during the 2009 recession when it dipped to 10 million.

It would be reasonable to expect the auto sales to stay above 15-17 million range for next couple of years. The sales of trucks and SUV’s are also improving and will help GM and Chrysler.

Finally GM and Chrysler are global companies and have significant sales outside U.S. They will benefit from growth in demand in the U.S and across many other markets.

2. How do you value labor intensive businesses like auto/steel ?

(Pabrai) Labor costs are 5% of the price of a car. BMW manufactures cars in Germany, which is the highest labor costs environment in the world but they have the highest margins

Labor cost was not the defining factor for GM to go bankrupt, rather the defining factor was terrible products. However the product quality and offering of american manufacturers are comparable or better than other manufacturers for the first time in many years.

3. How will 30 million cash investment in Stone trust insurance by Dhandho holdings improve the intrinsic value and why hasn’t it resulted in improved underwriting profits ?
(Pabrai) StoneTrust’s growth in premium in the past 2-3 years did not match their growth in capital. Dhandho holdings infused capital into Stonetrust insurance to improve financial strength and meet rating requirements. However This investment will not be used in the business.

The infusion of capital to StoneTrust has nothing to do with underwriting profits. The underwriting profits or losses are coming from the dynamics of the business.

Stonetrust is very conservative in estimating loss reserves and we believe conservative reserves makes good business sense and has tax benefits.

4. Would you buy back share in Dhandho holdings before IPO to provide liquidity to shareholders ?

(Pabrai) None of the investors have approached us so far with a request to buy back shares so this is a hypothetical question. If there is such a request we have two options
Approach new investors to raise capital
Buy back shares to provide liquidity to investors

5. Can you share your thoughts on the nature of returns, what percentage can be attributed to change in earnings multiples compared to growth in intrinsic value ?

We invest in businesses based on our assessment of where it’s going rather than its current earnings, so to a great part our returns should track the growth in intrinsic value.

6. Can you share your thoughts on the strength of Horsehead’s balance sheet and its ability to withstand business cycles ?

(Robert Scherich, VP & CFO at Horsehead Corp)
Horsehead is going through transformation
We are in the process of de-risking our balance sheet and our focus is to maintain liquidity
We are concerned about the commodity prices, but have hedged for the short term.

7. With easy access to information and decreasing attention span, do you expect the timing between super cycles or bubbles will shrink ?

(Pabrai) Historically bubbles are more frequent than we think. There is always a bubble forming is some corner of the world all the time.

The cause of these bubbles are usually local and peculiar to specific markets or nations. For example recently we saw a bubble deflate in the chinese stock market. There are many theories explaining the stock recent crash in the chinese stock market. Charlie Munger has a politically incorrect explanation.

According to Munger The chinese are on average better than the rest of us in math due to rice cultivation. Rice is difficult to produce compared to other crops and require lot more math skills during cultivation in order to calculate the requirements. So over thousands of years of evolution they ended up with better math skills. However due to their deep interest in math, they have developed an innate desire for gambling.

The chinese government has regulated gambling and hence the attention of the population shifted towards real estate/housing. After they realized that housing is not going up anymore, they shifted their focus to the stock market. The government also played a role in fueling this bubble with its policies encouraging investors to take on leverage and risk.

There are many such examples in the history of bubbles and crashes of stock markets across the world.

8. What books would you recommend to a 14 year old who is interested in investing ?
Warren Buffett the making of an american capitalist by Roger Lowenstein
Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger by Peter D. Kaufman and Ed Wexler
Berkshire letters to shareholders ( Better than going to college )

9. What are your thoughts on GM – Chrysler merger ?
(Pabrai) Chrysler CEO, Sergio Marchionne is a poker player and he likes to play poker in real life as well. He is a tremendous manager and GM is the beginning of a poker game he is playing

If GM and Fiat merge, they are expected to have a cost savings in the range of 5 billion to 7 billion. The combined enterprise value of the company post merger will be in the range of 35 billion. The merger would also result in reducing the top 3 truck manufacturers to just 2 truck manufacturers.

I have observed that the rhetoric from Sergio goes up as the price of GM stock goes down, however we are not banking on the merger for our returns.

10. Is it prudent for individual investor to use moderate leverage ( e.g. 10% ) so that they are not forced out of their position in the event of a market crash but at the same time they can improve their returns by the use of leverage ?

It is better for individual investors to maintain a decent cash position and not invest 100% of their funds in the stock market.

Charlie Munger was asked similar question few years back, the question was
“How would I get rich fast”.
Munger’s answer to that question was that if you consistently spend less than you earn over a lifetime even with modest returns you will get rich.

The tendency to get rich faster ( specially with the use of leverage) is dangerous. The only time I would consider leverage in during deep crashes like 2008, but even there it is not necessary if you have cash reserves.

It makes no sense to risk any portion of your net worth even if the probability of losing it is remote. My recommendation is to never use leverage,

11. Is there a minimum ownership stake you would like to see the directors and executives have in a given company to make sure that their interests are aligned with the shareholders ? Do you prefer if they are options or direct purchases in the open market ?

We prefer if the management has ownership stake, however it is not a must. We have invested in companies where the management didn’t have significant ownership of the company’s stock. It’s a checklist item but not an absolute rule.

12. Can you please explain your process of evaluating a investment opportunity, specially from an individual investor’s perspective ?
The process is simple :

  • Be a shameless cloner – Only consider investments of well respected investors
  • Stay within your circle of competence
  • Buy the company if it’s trading at half its intrinsic value.

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