How Mohnish Pabrai DESTROYED The Market By 1,204% (MUST Watch Interview)

Summary

The 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

00:00

🤔 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.

05:01

🚫 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.

10:04

💡 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.

15:05

📈 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.

Keywords

💡Investor

An investor is someone who commits money, capital, or other resources to an endeavor expected to generate a profit. In the context of the video, the investor is considering the purchase of stocks and must understand the business they are investing in. The script emphasizes the importance of an investor's due diligence before buying a stock, highlighting the need to know the market capitalization and whether the investment is within their 'circle of competence'.

💡Stock

A stock represents a share in the ownership of a company. It is a type of security that signifies the investor's proportionate ownership and equity in the company. The video script discusses the ease of buying and selling stocks through modern technology and the importance of understanding the underlying business of the stock before investing.

💡Market Capitalization

Market capitalization, often referred to as 'market cap', is the total market value of a company's outstanding shares of stock. It is calculated by multiplying a company's shares outstanding by the current market price of one share. In the script, the speaker uses market capitalization as an example to illustrate the importance of knowing the total value of a company when considering buying its stock.

💡Circle of Competence

The 'circle of competence' is a concept in investing that refers to the range of areas or businesses an investor understands well enough to make informed decisions. The video emphasizes this concept, suggesting that investors should only invest in businesses they understand deeply, as exemplified by Warren Buffett's approach to investing.

💡Fundamental Analysis

Fundamental analysis is a method of evaluating a security's intrinsic value by examining related financial, economic, and other qualitative and quantitative factors. The script mentions that even after conducting fundamental analysis, pundits on TV still provide stop-loss recommendations, which the speaker finds questionable.

💡Stop-Loss

A stop-loss is an order placed with a broker to sell a security when it reaches a certain price. It is designed to limit an investor's loss on a position in a security. The video script criticizes the practice of setting stop-losses, especially for serious investors who should be focused on the long-term value of the stock rather than short-term market fluctuations.

💡Auction-Driven Markets

Auction-driven markets are markets where prices are determined by the interaction of buyers and sellers in an auction-like process. The script uses the analogy of a flat's market price to explain how stock prices can fluctuate widely in auction-driven markets, underscoring the irrationality of stop-losses in such contexts.

💡Indexing

Indexing is a strategy of a portfolio that is designed to mirror the performance of a specific index, such as the S&P 500. The speaker in the script suggests that for most investors, due to the complexity of stock picking, indexing might be a better approach as it offers diversification and low transaction costs.

💡Compounders

Compounders are companies that can consistently reinvest their earnings at high rates of return, leading to substantial growth in their intrinsic value over time. The script discusses the importance of identifying and investing in such companies, as they offer significant long-term gains.

💡Fair Value

Fair value is the estimated worth of a company or an asset at a particular time. It is derived from financial analysis and is used as a benchmark to determine whether to buy or sell an asset. The video script mentions the concept of selling a stock at around 90 to 95% of its perceived fair value, indicating a strategy for realizing gains while still allowing for some growth potential.

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