How Mohnish Pabrai DESTROYED The Market By 1,204% (MUST Watch Interview)
Summary
TLDRThe speaker emphasizes the importance of understanding the underlying business before investing in stocks. He highlights the concept of 'circle of competence' and advises investors to only buy stocks they fully understand and are confident in. He also discusses the flawed practice of setting stop-losses for serious investors, as markets are auction-driven and can significantly fluctuate. The speaker suggests that investors should focus on businesses with strong growth potential and great management, rather than just looking for undervalued stocks. He concludes by sharing his experience of selling too early and the importance of recognizing when a stock is egregiously overpriced before considering selling.
Takeaways
- 🧐 Investing requires understanding the underlying business and its market capitalization, not just the stock price.
- 🏷 The concept of 'circle of competence' is crucial; investors should only invest in areas they understand deeply.
- 🤔 Before buying a stock, consider if you would be willing to buy the whole company at its current market value.
- 📉 Stop-loss orders are not recommended for serious investors, as market prices can fluctuate widely in auction-driven markets.
- 🏠 The speaker compares stock prices to real estate prices, illustrating how daily fluctuations are not indicative of true value.
- 📈 For long-term investments, focus on companies with strong growth potential and management, rather than just low prices.
- 🔮 When selling a stock, it's more complex than buying as it requires predicting the future value and performance of the company.
- 🚫 Selling a compounding stock should only be considered when it is 'egregiously' overpriced, not just fully or slightly overpriced.
- 💡 The speaker emphasizes the importance of patience and holding onto stocks that have strong fundamentals, even if they fluctuate in price.
- 🌐 In a market with many listed companies, not all will be efficiently priced, presenting opportunities for value investors.
- 📊 The speaker suggests that even in a bull market, there are likely to be misunderstood businesses that present good investment opportunities.
Q & A
What is the first consideration an investor should have before buying a stock?
-The first consideration an investor should have is understanding the underlying business they are investing in and having a point of view on where the business stands versus the market capitalization.
Why is knowing the market capitalization important before buying a stock?
-Knowing the market capitalization is important because it tells you what the entire company is worth, similar to knowing the price per kilogram when buying rice in the market.
What is the concept of 'circle of competence' in investing?
-The 'circle of competence' is a crucial concept in investing, which refers to the area of knowledge or understanding within which an investor can make informed decisions. It helps in focusing on businesses one understands and avoiding those outside this area.
According to the transcript, what percentage of stocks would Warren Buffett consider outside his circle of competence?
-Warren Buffett would consider approximately 95% of stocks outside his circle of competence.
What should an investor do if they understand a company like Apple and it's within their circle of competence?
-If an investor understands a company like Apple and it's within their circle of competence, they should then ask themselves if they would be willing to buy the whole company for its current market capitalization. If yes, they should buy the stock; if not, they should avoid it.
Why does the speaker suggest that most investors should consider indexing as a good idea?
-The speaker suggests indexing because it allows investors to buy a broad market index with low frictional costs, and it averages out over time, reducing the need for constant monitoring and decision-making.
What is the speaker's view on the use of stop-loss orders for serious investors?
-The speaker believes that the notion of stop-loss orders should be done away with for serious investors, as it does not make sense to sell a fundamentally sound investment just because the price has temporarily dropped.
Why does the speaker compare the idea of setting a stop-loss on a stock to selling a flat at a loss?
-The speaker compares setting a stop-loss on a stock to selling a flat at a loss to illustrate that if you bought an asset because you believed it was fairly priced and intended to hold it as a long-term asset, selling it at a loss due to a temporary drop in price contradicts the original investment thesis.
What is the speaker's opinion on the importance of buying stocks within one's circle of competence?
-The speaker emphasizes that buying stocks within one's circle of competence is of utmost importance, as it allows investors to make informed decisions and avoid investing in businesses they do not understand.
What does the speaker suggest as the best approach to finding investment opportunities in a market that may be fairly valued or overvalued?
-The speaker suggests that even in a market that is fairly valued or overvalued, there will always be misunderstood businesses or opportunities that are undervalued. Investors should look for such opportunities, focusing on businesses with secular tailwinds, great management, and long growth engines.
How does the speaker define an 'egregiously priced' stock and when should one consider selling it?
-The speaker defines an 'egregiously priced' stock as one that has reached a valuation that is significantly over its perceived fair value. Investors should consider selling such stocks when they are not just fully priced or overpriced, but egregiously priced, giving great companies with strong growth some leeway in their valuation.
Outlines
🤔 The Importance of Understanding Stocks Before Investing
The speaker emphasizes the complexity of stock investing, noting that most people underestimate it due to the ease of buying and selling stocks through digital devices. They stress the importance of understanding the underlying business of a stock and its market capitalization before investing. The concept of 'circle of competence' is introduced, highlighting that even successful investors like Warren Buffett focus on a small percentage of businesses they understand deeply. The speaker advises investors to only buy stocks if they are within their circle of competence and to consider whether they would be willing to buy the entire company at its current market value. They also suggest that for most investors, indexing might be a safer and more effective strategy due to the inherent complications of stock picking.
🚫 The Folly of Stop-Loss in Fundamental Investing
The speaker discusses the concept of stop-loss, a practice often used by traders but not by serious investors. They argue that stop-loss is not applicable to fundamental investors because it contradicts the long-term investment philosophy. Using the analogy of a flat purchase in Mumbai, the speaker illustrates how markets are auction-driven and can significantly fluctuate in value, which is why daily price movements are not indicative of the intrinsic value of an asset. They share their personal experience with investing in Rain Industries, explaining how they held onto the stock despite market fluctuations and were rewarded with significant gains. The speaker concludes that investors should focus on the fundamentals of a business and its long-term potential rather than setting stop-loss levels.
💡 The Significance of Circle of Competence and Obvious Opportunities
The speaker elaborates on the concept of 'circle of competence' as a crucial principle in investing, stating that investors should only consider opportunities that are painfully obvious and within their understanding. They advocate for a hands-off approach to investing, where one should wait for opportunities that are so compelling that they 'scream' to be bought. The speaker also discusses the current market conditions, suggesting that even in a fairly valued or overvalued market, there are opportunities to be found, particularly in misunderstood businesses. They emphasize the importance of identifying and investing in companies with strong growth potential and tailwinds, rather than focusing solely on undervalued assets.
📈 Deciding When to Sell a Compounding Stock
The speaker tackles the complex issue of when to sell a stock, especially a compounding one that has appreciated in value but still has growth potential. They acknowledge that selling is more complicated than buying because it requires predicting the future performance of a business. The speaker advises against selling a compounding stock when it is fully or slightly overpriced, suggesting that investors should hold onto such stocks until they become egregiously priced. They also share their experience of selling too early and missing out on significant gains, highlighting the importance of recognizing a business's true potential after owning it. The speaker encourages investors to give great companies with strong growth and management some leeway and to sell only when the stock's price clearly exceeds its future value.
Mindmap
Keywords
💡Investor
💡Stock
💡Market Capitalization
💡Circle of Competence
💡Fundamental Analysis
💡Stop-Loss
💡Auction-Driven Markets
💡Indexing
💡Compounders
💡Fair Value
Highlights
Investors should understand the underlying business before buying a stock.
The ease of buying and selling stocks can lead to underestimating the complexity of investing.
Investors often lack knowledge of a company's market capitalization.
The concept of 'circle of competence' is crucial in investing.
Warren Buffett considers most stocks outside his circle of competence.
Most investors should also consider most stocks outside their circle of competence.
Investors should assess if they would buy the whole company at its current market value.
Indexing is recommended for most investors due to its simplicity and low cost.
Stop-loss is not a concept used by serious investors in the US.
Stop-loss is counterproductive for long-term investors focused on fundamentals.
Auction-driven markets like stock exchanges can lead to undershooting and overshooting of prices.
The idea of stop-loss is akin to selling a property at a loss due to market fluctuations.
Investors should focus on the long-term value of a stock rather than short-term price drops.
Buying a stock should be a no-brainer, with the idea being obvious even to a 7-year-old.
Even in a bull market, there are opportunities in misunderstood businesses.
Prefer buying a growing company over a cheap no-growth company.
Investors should look for companies with secular tailwinds and long growth engines.
Selling a stock is more complicated than buying, requiring a forecast of the company's future.
Great companies with growth potential should be given leeway and not sold at full price.
It's important to learn about a business after owning its stock to better understand its potential.
Selling too early can lead to missing out on significant gains.
Transcripts
the first thing a investor ought to ask
themselves before they buy a stock uh
even before we get to price and so on
is buying a stock uh is is a far more
complicated activity than most people
seem to think so what's happened with
the development of markets is on a
smartphone or a tablet or a laptop we
can in seconds buy one of thousands of
companies and uh there's no effort
required to buy a stock no effort
required to sell a stock but uh in order
to do well one really needs to
understand the underlying business and
to have a point of view on kind of where
that is versus the the market
capitalization so I'll give you an
example uh many times in the US like
I'll go to my health club for example
and one of the members will ask me hey
Mish uh should I buy Apple should I buy
Apple stock and I turn the question
around to them I say uh hey John what's
the market cap of Apple and they look at
me with a puzzle look they said the
stock is at 170 I said no no what is the
market capitalization and they don't
know okay so the first thing if you're
going to buy if you're going to go buy
some rice in the market you're going to
know what is the price per kilogram so
the first thing is that if you're going
to buy a stock at least know what you
can buy the whole company for for and
most investors don't have that knowledge
which is amazing and so the first the
first thing a investor ought to ask
themselves before they buy a stock uh
even before we get to price and so on is
is this within my circle of competence
now circle of competence is a very
important concept one of the most
important Concepts in
investing a person like Warren Buffett
would consider something like 95% of
stocks outside his circle of competence
and uh he says that you know probably 97
98% of things that show up on his desk
go into a box called the two hard pile
he can't figure them out okay so there's
just a sliver of businesses now if
Warren Buffett can't figure out 95% of
businesses for the rest of us humans we
can't figure out 99% of them so most
things are going to be outside the
circle competence of most investors so
now let's say an investor answers
question correctly yes I understand
apple and I understand it's within my
circle competence right so the next
question then comes up is the question I
asked what could you buy the whole
company for and then the second question
investor should ask is so let's say
investor knows apple is worth a trillion
dollars for example so the question I
would ask them is that if your family
had a Fortune of 4 trillion would you be
willing to put 1/4 of that fortune into
apple and if the answer is yes buy the
stock if the answer is no don't buy a
single share and so these are just very
simple which is you know look at your
net worth look at your family's fortune
and are you willing to put a quarter of
it buying the whole company that you
want to buy 100 shares off and so these
are basic things that most investors
unfortunately
uh don't focus on and so I feel that uh
investing in stocks figuring out you
know what they're worth uh what your
circle of competence is these are
complicated issues so for most investors
it's a really good idea to index uh
because indexing you can buy uh nifty50
index or any broad index in India uh for
basis points you know the the frictional
cost for ETFs and all is very low and
and the second is you average out over
time so every month when you get your uh
your salary check take a small portion
first put it into fa savings and then
don't worry about it uh what I would say
set it and forget it fill it shut it
forget it Theo hondai yeah exactly and
uh so that's why I think that buying
stocks uh should really be an
exception rather than the norm okay uh
the second topic uh and before we move
on to the more nuanced investor a second
thing that I wanted to talk to you about
again we discussed this on on email
about this whole notion of stop loss
that you that you find amusing in India
because apparently in the US nobody
deals with the concept of stop- loss now
let me tell you a peculiarity here Mish
because we do this day in day out for a
living a lot of technical experts who
come in give stop losses they are
mandated too as well because it's a
trading that they have they don't care
about the fundamentals they only
bothered about the charts right you
would still believe that the notion of a
stop- loss from a serious Investor's
perspective should be done away with we
don't find too many people talk about
stop losses if they are serious
investors but you believe that there is
enough and more talk about stop loss
happening on fundamental investing as
well that's right so so just to clarify
uh we're not talking about the
speculators and Traders so uh more power
to them more uh but but when we come to
investors uh I I actually find plenty of
pundits on on uh on TV who have done
fundamental analysis and they give
targets and they give stop losses and uh
and I find that really so uh the the
nature of markets so one of the reasons
why we can make a lot of money in equity
markets is because they're auction
driven and auction driven markets are
very different from almost any other
kind of market so to give you an
illustration let's say I bought a flat
in Mumbai for 1 CR I don't know if we
can get one for 1 CR or not but let's
let's play along uh we got one maybe in
the in the periphery of Mumbai Okay so
we paid a CR for for the flat and we did
research and we found that it's the
right price and we bought it and uh now
we want to know how the price of that
flat changes every day so I have a
friend who is a real estate broker and I
tell my friend the real Brer listen
we're going to have chai with pabra
every day you and I going to have a cup
of tea and every day just come and tell
me what the price market price of my
flat is okay so you bought the flat next
day you invite your broker friend and he
says so I ask him so what's the price on
my flat he'll say uh listen idiot it's
still one CR okay I call him after two
days he's still say still one CR and
after maybe two months he says you know
uh a little change in transactions it's
actually 1.05 crores now it's 1.05
crores it's gone up a little bit and if
you did this every day and you just
wrote down the price he was giving you
and did it for 365 days you would at the
extreme end find it went to somewhere
between 95 lakhs and maybe 1.1 crores or
1.15 crores in that range right now
let's say my flat is a listed company on
the Bombay Stock Exchange but the only
asset is this flat and every day the
price is doing whatever it's doing in
the market and we chart that daily price
movement what we're going to find is in
a 52 we period the range may be
something like between 70 lakhs and 1.3
crores and the reason is that auction
driven markets unders shoot and
overshoot and it is the undershooting
and overshooting that creates the
opportunity for people like me right and
so so basically uh the idea of a
stoploss would be like I bought the flat
for a CR and uh after 6 months my broker
tells me you know prices have dropped
about 5% and I say to him okay that's my
stop loss and I'm now going to sell you
my flat for 95 lakhs please sell it
right it would be the equivalent of
doing that the reason you bought the
flat for a CR because you thought that
was fairly priced and the second reason
you bought it because you wanted to hold
it as a long-term asset so the same
thing with stocks if you bought a stock
for 200 rupees or it has a market cap of
1,000 cror you bought it because you
thought it's worth 2,000 cror so if it
goes from 1,000 crores to 900
crores you will you will sell it with
stop losses and it makes no sense so I
own a company called rain Industries
right and I I bought that stock about
about 2 and a half years ago and when I
was buying the stock it was at about 30
rupees a share and by the time I
finished buying it got up to 45 rupees a
share went up almost 50% because almost
bought 10% of the business and after I
finished buying it proceeded to go down
just like everything I buy okay the
stock knows I bought it and it decides
Mish is done now let's go down okay if I
had engaged in stop losses uh rain went
down to 40 even went down to 35 after I
finished buying and I did nothing and
so now rain is north of I don't know 360
rupees and so that whole opportunity
would have been gone it would have been
no sense for me to put a stop loss at 30
or 35 or 40 because I thought it was
worth a lot more so I think I think
investors ought to focus on making sure
that that the stock is within the circle
of competence that it's worth a lot more
than it's valued at and when once you
have those two things a stop- loss makes
no sense wow so circle of competence I
think that's that's the preliminary the
most important thing yes three the three
most magical words for Ben Graham okay
great now if if circle of competence was
were the three most magical words from
Ben Graham I think one of the most
amazing things that I've seen you speak
about a lot I've also saved that image I
can't find it right now but you remember
I sent that image to you which said
something like uh most of the times when
I'm looking for an idea I need the idea
to scream at me saying buy me until then
I don't go out in in the in the US you
know we have these uh wooden uh things
things called 2x4s which we use in in
housing construction I need to be hit on
the head by a 2x4 before I should buy a
stock yeah so before buying a stock it
has to be complete and total no-brainer
okay uh if if I have to turn on Excel
it's automatic rejection if I cannot
describe the idea to a 7-year-old in 2
or 3 minutes it's a automatic Rejection
it needs to be painfully
obvious painfully obvious to The Village
Idiot why we should be buying where are
such opportunities currently in such an
overheated market and I okay let me
rephrase I'm not using the term
overheated Loosely I'm just saying the
markets have rallied we may not be in
bubble territory for certain markets and
all of that is a subject of everybody's
individual opinion only future will show
whether we were there or no but let's
assume for a moment's sake we are not in
bubble territory but we are in a in a
space where the markets are at worst
fairly valued you will probably not get
opportunities where you get hit by 2x4
well you know we are in wonderful lower
paril right now and within I would say
10 or 15 km of the lower par rail from
here to the next 15 km is a boatload of
opportunities in real estate okay fine I
didn't want to get down to real estate
so soon we we'll get to that but you
even right now what I'm trying to find
out Bish is that you are still in a
market like this looking for ideas which
are just too painfully obvious you're
not going well I think I think I think
even in
uh in rampant bull
markets there are always misunderstood
businesses now rampant bull markets will
cause a lot of overpricing and I think a
lot of things are overvalued but there
are plenty of things that may be fairly
or deeply undervalued in in a market
like India with 5,000 listed companies
more than 5,000 listed companies it is
just not possible in auction driven
markets that all of them are efficiently
priced we are going to have underpricing
and we're going to have overpricing just
the nature of the Beast Okay the reason
why I asked this question is a lot of
your peers a lot of people uh within the
same space we did a small series with
ramdev agal sometime back in wonderful
guy good friend yeah okay so and ramdev
says often that I find Value in growth
so the stock may not be underpriced or
may not be a screaming buy but if there
is growth that he sees over the period
of four four 5 6 10 years maybe
anded to by the
wayers then that becomes anity to are
you looking for such opportunities in
India because India is per se a growth
Market you are definitely better off
buying a growing company over a cheap no
Growth Company okay so if I buy an asset
that is cheap that has very limited
growth all I'm going to do is cover the
gap between it may be worth uh 100 rupes
a share I'm getting it for 50 60 rupes a
share I'm just going to make the 40 or
50 rupees over whatever period of time
it takes to get there now if I'm buying
a company that has secular Tailwinds
great management and long growth engines
as long as I'm not paying up too much
it's the best place to be okay and so I
think I think ramdev in my opinion is
one of the best investors in the country
and I think uh well the only only I
would say critique I would have Ram is a
tad too optimistic at times but he's got
it absolutely right that you bet on the
growth engines and you bet on the
long-term secular growth engines which
have got a lot of Tailwinds and uh and
those in general uh are going to do
really well so uh so I think I think
they've got it uh they've got mostly
they've got it mostly right okay now the
reason why I asked you this question is
very recently in one of the interviews
or intera or quotes that you gave out
you mentioned that you know it might be
really important to buy in
Compounders uh from a long-term
perspective and there are some questions
that I've gotten with regards to that as
well somebody is asking and I have a
question of my own as well as to how
does monish decide if a compounder
compounder is egregiously prized and has
reached the Tipping Point of selling
versus your earlier stance of selling at
about 90 to 95% of the perceived fair
value
how do you decide this how do you decide
that a compounder has reached a value
which is overpriced and therefore you
would want to get out of it okay so uh
let's unpack the question a little bit
sure so we've got two types of things we
got to do with companies right so we're
the points at which we buy them and why
we buy them and the points at which we
sell them and why we sell them sure um
buying is complicated selling is 10
times more complicated okay so so when
we're trying to buy relative to selling
It's relatively straightforward we want
to know what the growth engines are if
you're going after a growth company we
want to know what we're paying for that
growth and we want to try to figure out
where is this company in 5 years or 10
years versus what we're paying for it uh
and so those are relatively
straightforward uh compared to the
selling question uh the selling question
uh is a more complicated question uh
because one of the things uh we are
forced to do is we're forced to look out
into the future uh maybe a few years out
to try to figure out what is the future
of this business and for most companies
even the Insiders have a very fuzzy idea
about the future and so so the thing is
that if we buy a compounder at uh a
value price that's a relatively easy
exercise because we we're not paying up
but the difficulty comes in when it goes
up in price and it looks fully priced
but still has a lot of tail length and
still has great management still has a
lot of great growth in front of it so
the best that I've been able to answer
the question is a great company with
great growth with great management uh
give them some leeway so don't sell them
when they're fully priced don't sell
them when they're overpriced sell them
when they're egregiously priced okay now
what each of these levels are I'll leave
to the viewer but it should be obvious
you know when is it fully priced when is
it overpriced when is it egregious so
what I've learned what one of my biggest
mistakes has been is selling too
early I have watched 100 Baggers that I
bought who went on to become 100 Baggers
so many times after I was out and i' had
only captured the double or the triple
and I didn't capture the remaining 98 or
97 times that it went up but when you
buy you don't know it's going to be 100
bager absolutely in fact you learn you
learn about a business only after you
own it so you may do all the analysis in
the world but you're really going to
learn the business after you own it and
that still doesn't mean viewers that you
don't try and learn about the business
before you buy it it should be in your
circle of
[Music]
competence
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