We Study Billionaires - The Investor’s Podcast Network - TIP517: Mohnish Pabrai's Dhandho Investment Framework

Starting point is 00:00:00 You're listening to TIP. Hey, everyone, welcome to The Investors Podcast. I'm your host, Clay Fink. I'm very excited for today's episode because I'm going to be covering the investing strategy of Monish Pabri. Monish is one of our very favorite investors to learn from here at the Investors Podcast Network, as he's been a guest on our show a number of times over the years for Preston, Stig, and William.

Starting point is 00:00:24 Since inception in 2000, Monich's flagship fund returned 781,000. percent to his investors net of fees relative to only 378% for the S&P 500. For much of this episode, I'll be covering my biggest takeaways from reading his book, The Dondo Investor, which was published back in 2007. During this episode, you'll learn the nine Dondo investment principles, why Dondo investors are able to earn outsized returns with minimal risk, how to find bargains in the market, The story of the Patels, who went from owning nothing in the U.S. to managing 50% of the motel industry in just 35 years? Why Dondo's love arbitrage opportunities? How investing relates

Starting point is 00:01:10 to gambling, Monash's seven criteria he goes through before purchasing a company, and so much more. At the end of the episode, I'll be discussing Monisha's holdings in his portfolio today, most notably Micron. With that, I hope you enjoyed today's episode covering Investing Great, Monash Pabri. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Warren Buffett has famously said that he is a better investor because he is a businessman, and a better businessman because he is an investor. Monash states that the Dondo investor is the expansion of that one sentence into a book

Starting point is 00:02:08 diving into that idea. So up until just recently, I had no idea what a Dondo investor was. I had first learned about it through reading TIP's investment newsletter called We Study Markets and knew I had to give this book a read given that it was written by Monash. If by chance you aren't yet subscribed to TIP's newsletter We Study Markets, you can do so by simply going to Theinvestorspodcast.com slash newsletter. If you're interested in staying up to date with markets and just personal development as an investor, I highly recommend you go subscribe at theinvestorspodcast.com slash newsletter.

Starting point is 00:02:45 All right. So now the Dondo investor is simply an approach to business that has minimal risk, but maximum reward, meaning that if you win, you win big. And if you lose, you may only lose a little bit. Said another way, the Dondo style of investing in business is taking asymmetric bets that give you disproportionate upside relative to the downside. An important part of this is minimizing the downside because Buffett says that the number one rule to invest is to not lose money.

Starting point is 00:03:16 And rule number two is obviously to not forget rule number one. We've all been taught that in order to increase returns, you must take greater risk. But when you study the investors that take this Dondo approach, they feel that you know. flip this idea totally on its head. Dondo investors have a way of taking on business endeavors that create wealth while taking virtually no risk. Monash tells a number of stories of business people who took this Dondo approach, the first of which was a group of people referred to as the Patels. 35 years before this book was published, there were practically no Patels in the United States. And at the time the book was published, the Patels owned more than $40 billion worth of

Starting point is 00:03:58 motels, paying $725 million in taxes, and employed over 1 million people. Over half of the motel industry was owned by the Patels in the United States, despite only being 0.2% of the population. Now, the Patels were from a specific area of India near where Gandhi was born. The Patels had their wealth seized, and they were driven out of Uganda at some point, and they were forced to go elsewhere. The United States ended up accepting a few. thousand of these families, and this group eventually entered the motel industry. When you study

Starting point is 00:04:33 immigrants that come to the United States, you oftentimes find that certain ethnic groups tend to stick to a certain profession or certain business. This is because the role models in our life play a big role in the path we end up choosing to follow. If we see someone who did quite well who had a similar upbringing, attended a similar school, had a similar lifestyle, then it's natural for us to take a similar path as well. It's what we're most familiar and most comfortable with, which really makes sense from that perspective. Now, why did the Patels enter the motel business specifically? Well, after World War II, there was a huge buildout of suburban life and interstate highway systems as the automobile became a staple of American life. By 1973, the U.S. had

Starting point is 00:05:21 entered a recession, and the motel industry had taken a downturn. And one of these Patel families saw a huge opportunity after losing practically everything they had in Uganda, and now they were just immigrants to the U.S. The father of the family was working a minimum wage job, and he figured out that he could purchase this motel largely with debt. And they would have minimal transportation and living expenses because they could live at the motel and not have to commute for work. So they buy this 20-room motel for $5,000 down, and rather than keeping the employees that worked there, they let them all go, and the family of five would handle all the operations of the business.

Starting point is 00:06:03 The competitive advantage that this Patel family created was to be the lowest-cost operator and have the same or higher levels of profitability per room than their competitors. Since they were the lowest-cost motel, their occupancy rates ended up being much higher than their counterparts. This Patel family's expenses were abysmally low. They spent practically all of their time working and didn't have time to spend money on recreational activities. They didn't have a mortgage payment.

Starting point is 00:06:32 They weren't commuting anywhere. When you're working all the time, it's kind of hard to have a lot of expenses, assuming that you're not spending a ton of money on the business itself. To add to that, they were vegetarians and just lived a really simple life and they just spend a lot of their time just working. The distress price for the motel ended up being $50,000 initially, and after the $5,000 down payment, the motel would bring in $15,000 in annual profit and an additional $5,000 in principal paid on the loan, netting the Patels of 400% return on their original investment. Turning back to this Dondo approach, when looking at the motel

Starting point is 00:07:12 deal, there was obviously some sort of chance that it would end up failing. If the economy entered a severe recession and enough business never came in to cover the expenses, then the motel would get foreclosed on. In that sort of situation, the Patels would have lost their $5,000 initial investment. If the economy does recover, though, then the bet pays off tremendously. Say the family netted $20,000 per year for 10 years, and the business is sold for the price it was originally bought. That would mean this investment would end up being a $20,000.

Starting point is 00:07:46 one bagger on their initial purchase price. This summarizes the Dondo approach, minimal downside with very high asymmetric upside. Let's say that there was a 10% chance that this deal wouldn't work out, and the Patel's lost all of their $5,000 that they initially invested. Well, that means if he made this bet twice, then there would be a 1% chance that this sort of arrangement doesn't work out both times. So if the family was willing to take two shots at this and go all in, then there was a 99% chance that it would pay off big in the end. After the first failure, of course, they would of course need to go back and work some sort of minimum wage job to save up the money again, to invest it for the second one. And of course, since the first motel ended up being a success for them,

Starting point is 00:08:33 the family was eventually flushed with cash and they were able to go out and purchase a bigger deal that was 50 rooms instead of 20. And the snowball effect started to come into play, which led to the Patels from this specific part of India to own 50% of the motel market in the U.S. in just 35 years. Before diving into more of the details on the Dondo framework, Monash also tells his own story of his own Dondo experience. Monash founded a business called TransTech Inc. And when he started the business, he had $30,000 saved up in his 401k. And he had $70,000 available in credit card limits. He did some research and discovered that if the business ended up not working out,

Starting point is 00:09:17 he could file for bankruptcy and simply wipe out his debts. And to make the jump slightly more comforting, his previous employer, he just quit at, told him that they'd love to have him back if his business ended up not working out. So in Monisha's eyes, he didn't see much downside in starting a business while he was young, being only 25 years old, and he had this opportunity in front of him that he just really had to seize. He started TransTech part-time in early 1990 while working his full-time job.

Starting point is 00:09:47 And then when he quit his full-time job, he had already signed his first client and had $200,000 in the annual revenue. He actually regarded staying at his full-time job, the risky path in life. As when he was in his 20s, it would be the only shot at life that he had at starting a business. as in the later years, he would have a family of his own, and starting a business would be much more difficult and likely more risky since his expenses would be much higher too. So if the business didn't work out, he would say loses $30,000 that was in his 401k. And if it did work out well, then it would likely net him millions of dollars at the very

Starting point is 00:10:27 least. And once he started getting the business established and he had a few customers and clients on board, he knew the business was then very low risk and was really a no-brainer in his mind. The business model was actually very simple that Monash implemented. It was an arbitrage-based business model where he leveraged India's deep expertise and knowledge in client server computing to satisfy the deep shortage of talent in the Midwest in the U.S. By 1996, his business was recognized in the Inc. 500, which represented the 500 fastest growing businesses in the U.S. Over the first 10 years, the business went from nothing to over $20 million in revenue,

Starting point is 00:11:11 and Monash never had to take in outside capital. Monash says that he ended up selling the business in 2000 for several million dollars. His initial $30,000, he quote-unquote, put at risk, had turned into a 150 bagger over 10 years, which he stated. is an annualized return of 65% per year. When he quit his job, he had a salary of $45,000, and in a few years, he was consistently making over $300,000 per year. In Monich's words, the magic is Dondo, huge upside with virtually no downside. It was a classic, heads-eye win, tails I don't lose much kind of bet. Monich then dives into the Dondo framework, which consists of nine core principles. The first principle is to focus on buying an existing business. The stories

Starting point is 00:12:05 that Monish told at the beginning of the book didn't include crazy startups, you know, where it's something like Elon Must starting Tesla, Jeff Bezos starting Amazon out of his garage, or Steve Jobs, creating a new form of computing. They were businesses that already existed and these businesses have been around for a really long time. This is a much less risk. business venture than operating a startup. The second principle is to buy simple businesses in industries with an ultra-slow rate of change. Warren Buffett once said, we see change as the enemy of investments. So we look for the absence of change. We don't like to lose money, and capitalism is pretty brutal. We look for mundane products that everyone

Starting point is 00:12:50 needs. The third principle is to buy distressed businesses in distressed industries. You're going to get the best deals when business isn't as good, and the general sentiment is really, really bad. The Patel's first got into the motel business during a recession. In the business environment for the industry was really pretty poor because people overall are traveling and they're spending less because they don't have as much discretionary income. As we all know, Buffett likes to be greedy when others are fearful and fearful when others are greedy. Monish states that Dondo investors intrinsically understand that the very best time to buy a business is when its near-term future prospects are murky and the business is hated and unloved. In such circumstances, the odds are high

Starting point is 00:13:39 that an investor can pick up cheap assets at steep discounts to their underlying value. The fourth principle is to buy businesses with a durable, competitive advantage or moat. For the Patels and the motel business, this was the ability to charge much less than all of their competitors and still maintain healthy margins. Other examples of a competitive advantage is access to resources your competitors don't have, having a highly skilled labor force, or having a strong brand awareness. The fifth principle is to bet heavily when the odds are in your favor. Again, this ties into the asymmetric upside we mentioned earlier where if you win, you win big, and if you lose, you only lose a relatively small amount. Charlie Munger relates this to

Starting point is 00:14:25 horse betting as he says, we look for the horse with one chance and two of winning, which pays you three to one. You're looking for a mispriced gamble. That's what investing is. And you have to know enough to know whether the gamble is mispriced. That's value investing. This reminds me of how Warren Buffett almost always has ample amounts of cash, partly because he had his insurance business and has to have cash available to pay out claims, but also partially to give him that optionality. During the great financial crisis, because he had a ton of cash and a ton of other people needed cash, he was able to invest in deals with great terms that earned him outsized returns. The sixth principle is to focus on arbitrage. Arbitrage is simply profiting by exploiting

Starting point is 00:15:14 price differences in two different markets. Buffett is actually currently in an arbitrage deal as he purchased a stake in Activision. Microsoft is in the works of purchasing Activision and Buffett stated that he plans on exiting the deal, and the goal with the investment is to make a profit when the deal closes, which is a strategy known as merger arbitrage. In a typical arbitrage play, you just can't lose. But in this merger arbitrage for Buffett, there is, of course, the chance that regulators don't approve of the deal, and Buffett is stuck holding his shares in Activision, which he very well may be okay with.

Starting point is 00:15:49 Arbitrages can be applied to businesses as well. In a way, Monish applied this arbitrage concept when he was meeting a need in the marketplace. He found labor in India and the demand for labor in the Midwest, and he connected the two, making the decision a no-brainer for both parties. If the arbitrage is so successful and so profitable, then eventually competition will flow in and close the gap on the mispricing in the market. Arbitrages can be found when entrepreneurs deliver a product or service to a market that isn't yet being serviced and has a desire to fill in for that demand.

Starting point is 00:16:25 Principle number seven is to buy businesses with big discounts to intrinsic value. As we've talked about in all of our episodes covering Warren Buffett, you want to purchase a business with a margin of safety to help minimize those chances of you losing money. In Buffett's number one rule of investing, as I mentioned, is to not lose money. Principle number eight is to look for low-risk, high-uncertainty businesses. The Patel's Motel's Motel's motel business did not have much risk to it. However, it did have a lot of uncertainty because of the looming recession and how bad the recession would end up actually turning out. The low risk is an obvious sign to look out for if you've listened this far into this episode,

Starting point is 00:17:06 but the reason why high uncertainty is actually desirable is because that is what's going to give you the depressed prices. The market really doesn't like uncertainty. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

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Starting point is 00:21:32 The reason meta stock is so depressed is because there is a lot of uncertainty going forward and the market really does not like uncertainty. Nobody really knows how much meta will end up spending on the Metaverse and how that will end up playing out for them whether they'll actually make money or if it will be a huge success. Principle number nine is that it's better to be a copycat than an innovator. The first few Patel's in the US paved the way for the remainder to head to the US and enter that business. Innovation can be a crapshoot and it's better to copy what works than to create something new. Monash is actually quite well known for cloning and shamelessly taking the best ideas

Starting point is 00:22:16 from the great investors such as Warren Buffett and Charlie Munger. It's pretty foolish to believe that you need to invent or create something new when you can just simply clone the best ideas that already exist. Not a lot of people listening to the show might want to go out and buy or start a business like the Patels did or Monash did in the 90s. And this is where the stock market comes into play. Ever since the creation of the stock market in 1790, many people have viewed. it as a piece of paper whose prices continually race up and race down, Monish highlights that a far

Starting point is 00:22:52 better way to view the stock market is how Benjamin Graham views them, and that's the ownership of a real business. The stock market allows anyone to own a publicly traded company and benefit from the cash that business creates, just like how the Patel has benefited from the cash that was created by their motel business. Monash then highlights six big advantages that the stock market offers versus buying and selling an entire business. The first advantage is the headache saved. When you purchase an entire business, it takes a tremendous amount of energy and dedication in order to make it successful. When you buy a stock, all you need to do is do your research up front and you don't need to go out and find managers to take care of the business of the stock

Starting point is 00:23:38 you're buying. You can buy as little or you can buy as much as you want. You can sell out whenever you'd like with just a few clicks on your computer. The Patels didn't have this advantage of being able to buy and sell whenever they wanted to. Plus, they had to spend so much time and so much headaches dealing with the business they had, which also gave them a lot more potential upside and sweat equity as well. Another advantage is that when a wholly owned business is sold, both parties in that transaction tend to have a pretty good sense of what the asset is worth. and they come to a rational price during the sale. And oftentimes, the seller will only want to sell at a time that is to their benefit.

Starting point is 00:24:21 I would also argue that many times the seller of a wholly owned business knows more about that business and the buyer does, so they're able to make a sale that is more beneficial to them. Instead of stocks being a conversation between the buyer and the seller, it's more like an auction system of buyers and sellers constantly placing orders and occasionally Finally, you'll find a wide divergence between the value of the business and the price that's quoted by the market. Other advantages include the ability to get started with a very small amount of money, having

Starting point is 00:24:54 the opportunity to buy into over 100,000 businesses that are all over the world, as well as very little transaction costs. Monash is a big believer that having an ownership stake in a few businesses is the best path to building wealth. And since there is no heavy lifting required and the opportunity to buy bargains, among other benefits, it makes buying stakes in publicly traded existing businesses a no-brainer for the Dondo investor. Monash then goes on to explain that he wants to own a simple business and to keep the intrinsic value calculation simple as well. He did an intrinsic value analysis in his book

Starting point is 00:25:34 on Bed Bath and Beyond based on the numbers back in 2005, and he came to the conclusion that the company was trading around its intrinsic value and offered a potential return of roughly 10%. After projecting out modest, conservative growth and discovering that the stock wasn't trading well below its intrinsic value, the stock was an easy pass for him because it didn't offer much upside, as well as a decent chance of delivering returns that were less than 10% per year. Simplicity is key when buying stocks, as he mentions that even Warren Buffett's style of investing is simple. The key to fighting the psychological warfare, he calls it, which I'll be discussing later, is to buy a simple business with a simple thesis for why you're likely to make a great

Starting point is 00:26:18 amount of money and unlikely to lose very much. If it takes more than a short paragraph, then there's a fundamental problem, and if it requires a complex model, then that's probably a red flag. Chapter 8 in this book covers investing in distressed businesses in distressed industries. He outlines his opinion on the efficiency of markets, noting that he believes that markets are largely efficient for most businesses. And the reason they aren't fully efficient is because humans are in control of the auction-driven pricing mechanism. When humans as a group are extremely fearful, the pricing of the assets they are fearful

Starting point is 00:26:57 of are likely to fall below their intrinsic value. And then on the opposite end of the spectrum, extreme greed can lead to very optimistic prices. In the stock market, when someone is extremely fearful about a company, they can log onto their brokerage and sell their position in just a matter of minutes. Monish then lists a number of ways you can find distressed businesses. The first of which is to simply look at the news headlines, as they tend to cover the negative news about a certain business or certain industry. Meta is a great example of this, as it's a company many people are talking about nowadays.

Starting point is 00:27:33 Second is Value Line, which is a research service which also includes a weekly summary of the stocks that have lost the most value in the last 13 weeks. I'm sure there are other sources as well with the internet nowadays showing stocks that are at either quarterly or 52-week lows or stocks with the lowest P.E. ratios, widest discount to book value, highest dividend yield, and so on. Third is he also recommends checking out what other super investors are purchasing, which is what you can find on Datarama, online on the activity tab, where it shows the recent buys and sells made by top investors.

Starting point is 00:28:09 These investors won't necessarily be focused on the most distressed businesses, but they will be looking for good value investments. Be sure to stick around until the end of the episode because I will be touching on Monisha's holdings in his portfolio, which for the most part only consists of two companies that are in the U.S., and the remainder of his portfolio is international. Lastly, he also recommends in the book to check out Joel Greenblatt's website called Value Investors Club, which is a membership site to present and receive ideas. Then Monish also recommends Greenblatt's book, The Little Book, The Little Book, that beats the market.

Starting point is 00:28:45 As we talk about numerous times on the show, you want to invest in businesses with a durable moat or competitive advantage. Capitalism is brutal, and people are always out there trying to find a way to earn more money or steal profits from a business that is earning a lot of money. A moat is what keeps competitors from stealing your lunch. Emote doesn't make it impossible to steal a share of a company's profits, but it makes it very difficult. You can try and make a better Google search, but Google is already free to users, and

Starting point is 00:29:15 building a better Google search may cost you billions of dollars, which may not even attract current users of Google anyways. Outside of the qualitative aspects of a business, such as the location Starbucks puts in their stores and how addictive their products are, another way to identify a quality moat is to look at the company's return on invested capital. Consistently high returns on capital are a good indicator of a strong moat. Monash gives an example that if it costs 700 grand to open a Chipotle and the average store generates 250 grand in free cash flow, then that's a really really really good business. This reminds me of how Dollar General, who is still building out stores,

Starting point is 00:29:58 will only build a store if they can hit a return on investment of 20% or more for a location. It's also important to understand that history tells us that eventually even the greatest businesses eventually enter the phase of decline. Charlie Munger points out that out of the 50 largest companies on the New York Stock Exchange in 1911, only one remains today, and that's General Electric. Over the very long term, the odds of any business surviving the forces of competitive destruction are very, very small. Because even the most durable modes don't last forever.

Starting point is 00:30:35 It's probably best to limit your discounted cash flow calculations to 10 years or less to avoid being too optimistic about the future. When you do find a company you're ready to wager on, Monice describes how the Dondo investor bets big. Monish, of course, prefers to have a highly concentrated portfolio with a handful of bets. He mentioned a Charlie Munger quote with regards to this, The Wise Ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't.

Starting point is 00:31:09 It's just that simple. Here's a clip of Monish talking about position. during his conversation with Stig on episode TIP 442. If anyone were to invest today with me in my funds, even though we limit ourselves to 10% beds, the top three positions for, I think all my funds are 50 to 60% of assets because they've run up, right? So we bought Micron a few years back and it's doubled and so on. If you had invested in me when I was starting out, then yeah, we would not have the same

Starting point is 00:31:43 degree of concentration because things haven't run up. But typically when investors have joined me, they've always come into a fund that probably the top three positions are 40 to 60% type concentration. And then by the time you get to the sixth or seventh position, you're looking at 90% of assets or something like that. I don't think I need to start a fund and say, I'm going to only have three picks. I could do that, but I think that the nature of investing is such, that it would get there anyway. And one of the things to keep in mind is there is this very high error rate, right?

Starting point is 00:32:20 We've talked about 40, 50% error rates. And so if you have 40, 50% error rate, and you have three pays, you could be wrong in two out of three of them. Right. And if you're wrong has a range of outcomes, right? Wrong means something could flatline, just doesn't go anywhere,

Starting point is 00:32:38 or something is a 20% loss. Or wrong could also be permanent. wipeout, zero on that. All of those are mistakes. Three bets could work as long as you don't have the wipeouts, right? I think you could have two of the three bets go sideways or be very modest winners and one could carry you. That's possible.

Starting point is 00:33:02 But I don't think you need to be that way. But I would say this, you know, sometimes we do get a chance to make investments where the odds are just so heavily stacked in your favor and the economics are so compelling that you would want to try to do more. It takes an incredible amount of conviction to invest so concentrated as he does, but he acknowledges that he's going to have some sort of error rate of, say, 40 to 50%, which is why us as individual retail investors should be careful not to bet too much on one stock. Now, this is one of my favorite chapters of the book as Monash describes the Kelly formula.

Starting point is 00:33:43 The Kelly formula calculates the optimal fraction of your money that should be invested into a favorable bet. The more favorable the odds, the more one should bet. If you're interested in learning the exact formula for this, you can Google it and figure it out exactly. In general terms, the Kelly formula is your edge divided by your odds. To use an example, if there was a coin flip where you're going to be a credit. it was, if it landed heads, you went $2, and if it was tails, you'd lose $1. The Kelly formula

Starting point is 00:34:14 suggests that you should bet 25% of your money each time you're given that opportunity. Monash then tells us the story of Ed Thorpe, who wrote the book, Beat the Dealer, where Thorpe described how he was able to gain an edge in Blackjack, and he used the Kelly formula to determine his bet sizes when he had an edge over the house. In the 1960s, there were tables with single-deck Blackjack, and Thorpe just made a killing off of it. They didn't know exactly how he was doing it, but he eventually got kicked out for consistently winning in these casinos. After Thorpe wrote his book on How to Win at Blackjack, the casinos, of course, read it, and then they wizened up by changing the game and adding more decks. Thorpe knew that the best

Starting point is 00:34:58 betting environment would be one where there were no table limits, the odds were vastly better, and the house was civil about taking losses, as well as the mob wasn't running the casino, and they weren't going to hurt him. And Thorpe found exactly what he was looking for, and it was the New York Stock Exchange and the options markets. He would master the options market simply by buying underpriced options and selling the overpriced ones and making up to $6 million per year while taking what he considered to be minimal risk.

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Starting point is 00:38:58 overwhelmingly in your favor was when Buffett invested 40% of his partnerships assets into American Express in November of 1963. At the time, American Express had a massive loss from a scandal and the stock was instantly cut in half. Buffett figured out that as long as customers stuck around with American Express, then the company was significantly undervalued. And from his perspective, there was practically no chance that the business was going anywhere. So in his eyes, there was practically no downside. Buffett rarely applied this level of concentration because these types of opportunities were so rare for him. So we can see that Buffett in his own way applied the Kelly formula of betting more when the odds were more heavily tilted in his favor.

Starting point is 00:39:47 This stock earned him a 3x return over the next three years that followed when he placed that bet. Pabri rounds out this chapter by stating, investing is just like gambling. It's all about the odds. Looking for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth. It's all about letting the Kelly formula dictate the upper bounds of these large bets. Further, because of multiple favorable betting opportunities available in equity markets, the volatility surrounding the Kelly formula can be naturally tamed while still still

Starting point is 00:40:22 running a very concentrated portfolio. In Chapter 12, Monash covered the concept of always having a margin of safety in your investments. Warren Buffett is asked about book recommendations. He often talks about what is considered to be the Bible of value investing, which is the intelligent investor. The three biggest ideas Buffett picked up from this book was first, the Mr. Market analogy of making the stock market serve you rather than you being a servant to the market. Mr. Market offers you a price every day that you can either take or leave, and there's no called

Starting point is 00:40:56 strikes in this game. Second is that a stock is a piece of a business, and to never forget that you are buying a business which has underlying value based on how much cash goes in and goes out of the business. Third is the concept of the margin of safety, which is to make sure that you are buying a business for way less than you think it's conservatively worth. When you focus on buying an asset for substantially less than its worth, we've reduced our downside risk. In the bigger the discount to intrinsic value, the lower the risk and the higher the returns.

Starting point is 00:41:29 Most of the time, companies trade near or above their fair value. And value investors like Monish are waiting for times of extreme distress and extreme pessimism as this is when rationality goes out the window and prices of certain assets go well below their intrinsic value. The March 2020 liquidity crisis is a perfect example of this as many market participants were forced to sell their stocks to get dollars for whatever obligations they had, or maybe sometimes it was even because of fear. And many of these people were getting margin called and being forced to sell, which further exacerbates the selling, making the discounts to intrinsic value even greater. In Chapter 15, Monish covered the art of selling a stock.

Starting point is 00:42:15 Up to this point, he mostly covered how to find a great investment. Before you decide to purchase the stock using the method he's describing, he lists seven criteria we should meet before purchasing. First, you need to understand the business well, and for the business to be in your circle of competence. Second, you need to know the intrinsic value of the business and understand how likely it is for the value of the business to change in the next few years. Third, the business needs to be priced at a 50% discount to intrinsic value.

Starting point is 00:42:45 Fourth, you need to consider if you'd be willing to put a large percentage of your net worth into the business. Fifth, the downside needs to be minimal. Six, the business needs to have a moat. And seven, the business needs to be run by able and honest managers. The difficulty with deciding to sell a company or not lies in the inability to predict the future. Sometimes we buy a stock and forces outside of our control lead our forecasts to differ

Starting point is 00:43:13 from what actually occurs in the business. A rule that Monish sets for himself is that you should only sell a stock within the first two or three years of owning it if you have a high level of certainty that the current intrinsic value is less than the market price. To use an example, say you buy a stock for $100, thinking that it's worth $200. And then the stock declines and it goes down from $100 down to $75. Maybe the thesis doesn't play out as you'd expect. the earnings drop for whatever reason, and you're certain that you misjudge the business when

Starting point is 00:43:48 making your original purchase. Maybe now, instead of your intrinsic value being $200, you determine it's actually around $50. Then you may want to consider selling because the company is trading at a price higher than your intrinsic value calculation, even though you'd be selling at a loss at that time. So it's all about understanding the business and having that high level of certainty about the company's intrinsic value when making the decision to both buy and sell. In the book, he also talks about what he calls a three-year rule. He wants to give a company three years to potentially converge towards its intrinsic value. In the first year, the stock in the business might turn against you, but you may still be right that the company is overvalued.

Starting point is 00:44:33 In giving yourself that three years to invest in a business is a lot of times enough to allow the market to realize the true value of that company. If it doesn't converge and the stock hasn't moved very much during that time, then you may decide that you were wrong on your thesis and you're going to sell out and allocate to a better idea because there's always that opportunity cost. You can only put a certain dollar in one place at a time without leverage, so you want to allocate your capital wisely and maybe reconsider the businesses that aren't performing as well as you anticipated. In reading through Monish's work and learning more about his approach in general, it's pretty clear that this guy takes more of the buy something cheap rather than buy something

Starting point is 00:45:17 quality approach. Like I've talked about in recent episodes, Buffett a lot of times is looking for a quality business that will be able to grow their earnings for a really long time, while Monash is the type of investor who will buy something that is obviously really cheap to him. This is how Buffett invested in his early days and likely trading out of that position in a few years when the price reaches its intrinsic value. Another thing I've learned from Monash is that you should find a few metrics that allow you to say no to a company really quickly. In order to find the types of picks that Monash is finding, you need to be able to sift

Starting point is 00:45:54 through a lot of different companies. If a company has a PE of 50, then that is probably a really good sign it's not even worth looking at for Monash. Whereas if a company has a PE of three and is training well below its liquidation value, then that is something that would get them interested and want to dig deeper. Again, you have to select metrics that work for your own approach, but I find it valuable to have an idea of the first things you want to look at when you're screening for companies. Next, I wanted to transition to talk a little bit about Monash's portfolio today. As of his most recent 13F, his fund Pabri investments owns two stocks with a sizable position in the U.S.

Starting point is 00:46:37 His 13F excludes any of his international holdings and he only holds two sizable positions in the U.S. The first is Micron, which is 92% of his U.S. holdings in his 13F. And then there's Brookfield corporations, which consist of most of that remainder. In an interview in the first half of 2022, Monish stated that, Micron was his largest stock holding. Micron is very popular amongst the prominent value investors, as Monish, Lee Liu, Guy Speer, Seth Claremont, among others, all have a position in it. Monish, in his interview with William Green, said that he collaborated with Lee Liu on Micron, and Lee Lou believes that it will perform very well as an investment.

Starting point is 00:47:24 Most of these investors purchased this company around the $30 to $40 per share range, prior to 2021, but interestingly, the stock has pulled back like much of the market recently. Here at the end of 2022, the stock trades at just under $50 per share after dropping from its 52-week high of $98. Micron is a semiconductor company and a memory chip designer and manufacturer based in the U.S. They produce two of the main memory chip technologies, which includes what is called the DRAM and the NAND. I'm not sure if I'm saying, those correctly, but it's DRAM and N-A-N-D. I'm definitely no expert on these semiconductor chips. At the end of 2021, they are the fourth largest semiconductor manufacturer company in the world.

Starting point is 00:48:12 Like I talked about in my episode covering Buffett's purchase of TSM in episode TIP 508, the semiconductor industry is very cyclical, so it's got these boom bus cycles, and you can clearly see that when you look at Micron's price chart on a longer time horizon over the last, say, 30 years. Cyclical businesses are difficult businesses to be in because when you're in the down part of the cycle, you have these manufacturers with excess supply met with a market that is low demand. This leads manufacturers to investing less in building out new manufacturing. Thus, when that increased demand comes back, you see the opposite dynamic where you have excess demand and not enough supply. So like a commodity business, the semiconductor industry can be quite cyclical.

Starting point is 00:49:01 When you look at Micron's revenue relative to their cost of goods sold over time, their costs of goods sold is actually quite stable, but their revenues are very volatile due to the shifts in consumer demand and the average selling price of their products. Just looking at their gross margins, you can clearly see that they go through these waves of up and down cycles. In 2010, gross margins are around 32%. These dropped to 11% in 2012, back up to the mid-30% range in 2014, and went way up in 2018, and now it appears to be more on the downtrend as gross margins sit around 41% in their most recent quarter.

Starting point is 00:49:44 And these figures are all based on the trailing 12-month numbers. Another difficulty with the semiconductor industry is the high capital expenditures that are required in this business, as the manufacturers need to continually invest and innovate to produce better and better products. It is very capital-intensive to build out the property, the plant, the equipment needed to manufacture these chips. Mycon alone spent $11 billion on capital expenditures in fiscal year 2022, while the company generated $30 billion. in revenues that same year. So quite a bit of investment relative to the money they're bringing in. Now, the bull case for Micron is that over a long enough period of time, the demand for these

Starting point is 00:50:30 chips are going to be higher, say, five plus years from now. Yes, we may see lower demand from year to year, say in 2023, but looking out at least five years, it's pretty likely that the demand for these chips is going to be much higher, which hopefully in turn will lead to much higher profits for a company like Micron. That's the bull case. Another item that these prominent investors have mentioned with regards to Micron is that this specific memory chip industry, because of the ruthless nature of the players in the industry, it's turned into what's called an oligopoly with three main players. There's Samsung, Hyneks, and Micron. Because you have this oligopoly dynamic, it's expected that the companies in this industry won't,

Starting point is 00:51:16 try and undercut each other as companies have done in the past. Thus, we may see a much less cyclical business in the future because with a market that's an oligopoly, it's in each company's best interest to not undercut each other. You can think about the soda market with Coca-Cola and Pepsi dominating. They naturally charge higher prices and they don't try and undercut each other because if they did, neither of them would end up making a decent profit margin. Another thing to consider with Micron is that the physical limitations of Moore's law are beginning to become reached, meaning that the primary driver of innovation within the semiconductor industry is coming to a halt, and the capacity of these chips won't be doubling every two years

Starting point is 00:52:02 as they have for decades. This lower speed of innovation may lead to their inventory lasting longer, which will then stabilize average selling prices, and then eventually lead to lower capitalization. expenditures that will be needed to continue to innovate on these chips. Again, as I mentioned in the episode covering Taiwan Semiconductor, this technology is critical to the technological age and where the world is moving. Monich mentioned in an interview that if Amazon were going to spend, say, $100 or $200 million on a data center, about 30% of that investment in the data center is going to be going

Starting point is 00:52:42 to the memory chip industry, which is just massive. I do like this pick from the perspective that you don't have to bet on a specific AI company or a specific electric vehicle manufacturer. I think that owning Micron allows you to be long human innovation and be long continued development of various technologies and benefit really wherever the world moves towards. Additionally, I do like to see that the company does earn good returns on capital. It's typically been in the mid-teens, but of course can vary quite a bit from the very much. from year to year as their profitability rises and falls. Because of the cyclicality, when times

Starting point is 00:53:20 are good, the stock can look really cheap because the earnings are quite high relative to the price of the stock, but the market knows that it's a cyclical business, and you can't rely on those high earnings year after year. The market essentially expects these earnings to eventually turn. I think the other stock in his 13F filing is also worth mentioning, which is Brookfield Corporation, ticker BN. Q3 of 2022 was the first time he purchased this company, and this is quite an interesting one because it's a special situation-type play. Brookfield Asset Management previously operated under the ticker BAM, and what makes this somewhat confusing is that the legacy business is transitioning to be under a new ticker of

Starting point is 00:54:05 BN. B.N. Brookfield Asset Management is a Canadian asset manager with a business. over $700 billion in assets under management, investing in various things such as gas pipelines, toll roads, data centers, solar farms, hydroelectric dams, and sky scrapers across five continents. This is a massive company that makes money three different ways, the first of which is investing their own capital in various projects, then they have their asset management business in which they invest other people's money in exchange for management fee. Then the third business is their stakes in publicly held companies that they founded and hold controlling stakes in. Brookfield has been a strong outperformer over the years, as they've had the tailwind of more and more capital wanting to

Starting point is 00:54:54 invest in alternative assets, which they really specialize in. Over the past 20 years, the stock's analyzed return has been 19% per year versus 10% for the S&P 500. Now, what the company announced they're doing is they're spinning off 25% of their asset management business into Brookfield Corporation because they believe that the asset management business deserves a higher multiple. Brookfield still owns the remaining 75% under the original company. The spinoff will be going under the ticker BAM and the legacy business is transitioning to BN. So Monish took a position in the legacy business, BN.

Starting point is 00:55:35 Now, it looked to me that Brookfield has a lot of tailwinds at its back. This has been a company whose assets under management over the past 20 years or so has just absolutely exploded. And the company foresees that growth to continue for the foreseeable future as they project their distributable earnings to grow by over 20% over the next five years, from $3.7 billion to $9.3 billion, which is really quite incredible. The reason they expect continued growth is because they're filling in the gap and filling that demand for alternative asset investing in new investments in infrastructure.

Starting point is 00:56:13 They have a really strong competitive advantage because they invests globally, meaning that they can send these investments to whichever country they believe will get the highest rate of return. I was digging into the company's 2021 annual report, and it's just insane how big this company is. And I suspect a lot of the TIP listeners haven't. even heard of this company or researched them. According to their annual report, they have roughly 180,000 employees globally. And since 2017, their distributable earnings have grown by 29% per year,

Starting point is 00:56:47 while their assets under management have grown at 25% per year. I would think that low interest rates would be a big tailwind for them as investors are searching for yield. So it'll be interesting to see how their assets under management continue to grow now that we have higher levels of interest rates now in 2022 going into 2023. I'd expect Brookfield to be a great company to own in terms of a longer-term compounder. As we see continued investments in growth in the asset management business, management expects they will be able to grow in the high teens over at least the next five years. The stock recently is selling off because I think there's a lot of confusion around the company and what this spinoff really means for investors.

Starting point is 00:57:34 When I look at Micron and I look at Brookfield, and I compare it to the Dondo checklist, I can see that Monish still applies the principles he laid out in his book years ago. And I see companies with wide moats, a potentially large margin of safety. In the case of Micron, he's betting over $91 million, so he's really betting heavily when he believes the odds are in his favor. Also, looking back to Monich's buys and sells. of different stocks over the years. He added Alibaba in the first half of 2021 and ended up completely exiting that position in the second half of 2021 as the stock trended down for pretty much the whole year.

Starting point is 00:58:14 So that's another interesting move as we've seen many investors bet on shares in Alibaba. All right, so that wraps up today's episode. If you don't already, be sure to click follow on the podcast app you're on so you can get notified of all of our future episodes coming out. And if you're interested in learning more about Monash Pabar, I can't recommend his book, The Dondo Investor Enough. With that, thank you so much for tuning in to today's episode. And I hope to see you again next week. Thank you for listening to TIP.

Starting point is 00:58:45 Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

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