Mohnish Pabrai on The Power of Compounding (TIP550)

Episode Overview

• Mohnish Pabrai shares his core investment philosophy, which emphasizes holding great businesses "forever" and accepting that a few big winners can offset many mistakes.
• The discussion explores the powerful influence of psychological biases on investors, highlighting the difficulty of maintaining objectivity and why human brains are not naturally wired for rational market decisions.
• A significant portion of the conversation analyzes why many brilliant founder-CEOs are often reluctant to execute share buybacks, even when their company's stock is clearly undervalued.
• The conversation contrasts different corporate cultures, particularly in Japan, where a focus on employee stability can often take precedence over maximizing shareholder returns through capital allocation.

Key Concepts

• Investment Philosophy: The core strategy involves buying exceptional businesses at reasonable prices and holding them indefinitely, regardless of subsequent valuation changes. Success hinges on a few major wins, making it a "forgiving business" that tolerates a high rate of mistakes.
• Psychological Biases: Human brains are evolutionarily optimized for survival, not investing, making individuals susceptible to biases like the "Lollapalooza cascade" described by Charlie Munger. Awareness is the first and most critical step in mitigation.
• Capital Allocation & Share Buybacks: Many founder-CEOs, despite being excellent business operators, fail to buy back their own undervalued stock. This hesitation is often due to psychological and cultural factors.
• Psychological Hurdles for CEOs: Executing a buyback requires a leap of faith, as it involves tangible cash leaving the company for a less tangible and non-immediate increase in stock value.
• Cultural Differences in Governance: Corporate priorities can vary globally. For example, many Japanese companies prioritize employee welfare and stability over shareholder-centric actions like aggressive share repurchases.
• Founder Evolution: Some founders are initially focused solely on building their business and may not recognize the value-creation power of buybacks, but can "wake up" to the concept over time, as seen with the company Reysas.

Quotes

• At 0:00 - "So the key in investing is to recognize two things. One, we're going to make a lot of mistakes. Two, this is a very forgiving business. You can be wrong even 98% of the time, still come out smelling really nice." - Mohnish Pabrai explains that success in investing doesn't require being right most of the time.
• At 0:32 - "So when they get fully priced, they don't get sold. When they get overpriced, they don't get sold." - Mohnish Pabrai emphasizes his strict buy-and-hold-forever approach to truly great businesses.
• At 2:50 - "How do you make sure to stay objective whenever you process information from people that you really like, perhaps you even admire them, and you have this Lollapalooza cascade of different biases...?" - Stig Brodersen asks Pabrai how he personally deals with the compounding effect of psychological biases when making decisions.
• At 3:20 - "Our brains... they've evolved over the millennia and they are not optimized for being great investors. They were really... our brain was optimized to help us survive." - Mohnish Pabrai explains why humans are naturally susceptible to investment biases.
• At 26:45 - "Why is that the case?" - The host asks why founders who are excellent at internal capital allocation often don't buy back their own stock when it's clearly undervalued.
• At 27:18 - "I actually sent them a PowerPoint in Japanese...on the benefits of buybacks, explaining...because I realized that a builder may not understand that." - Pabrai on his efforts to educate Shinoken's management on the financial logic behind share repurchases.
• At 27:35 - "What ended up happening is actually they took my advice in very large doses. So instead of...nibbling at a buyback like I was suggesting, they basically took one big gulp and bought it all." - Pabrai humorously recounts how Shinoken's management, instead of implementing a simple buyback program, decided to take the entire company private.
• At 28:51 - "Most Japanese managements and boards run the business for the benefits of the employees. They do not run the business for the benefit of the shareholders." - Pabrai explains a key cultural difference in Japanese corporate governance that often leads to poor capital allocation from a shareholder's perspective.
• At 29:55 - "In the case of Reysas, I think that...they have very much woken up to the fact that they blew it." - Pabrai gives another example of a founder-led company that initially missed the opportunity to buy back shares cheaply but has since realized its mistake and is now acting on it.
• At 30:37 - "Basically what ends up happening is you see cash leave your treasury and you don't immediately see a pop in the stock price." - Pabrai on the psychological barrier that prevents many CEOs from aggressively buying back stock, as they part with tangible cash for a less immediate and less tangible benefit.

Takeaways

• Adopt an extremely long-term mindset and resist the urge to sell your big winners, even when they appear fully valued, as this is the primary source of wealth creation.
• Proactively study the works of thinkers like Charlie Munger to build awareness of psychological biases, as this is the best defense against making irrational investment decisions.
• Don't be paralyzed by the fear of making mistakes; concentrate on finding a few exceptional opportunities with massive upside potential to compensate for inevitable losses.
• When analyzing a company, scrutinize management's capital allocation record, paying close attention to their willingness to repurchase stock when it is undervalued.
• Always consider the cultural context of a company's leadership, as priorities like employee stability may conflict with shareholder-friendly actions.
• Recognize that opportunistic share buybacks are a psychologically difficult and counterintuitive action for many managers, which explains why many fail to act even when it's logical.